Compumedics (ASX:CMP) Could Be At Risk Of Shrinking As A Company

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Compumedics (ASX:CMP), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Compumedics:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.041 = AU$987k ÷ (AU$42m - AU$18m) (Based on the trailing twelve months to June 2022).

Thus, Compumedics has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 9.8%.

See our latest analysis for Compumedics

Historical performance is a great place to start when researching a stock so above you can see the gauge for Compumedics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Compumedics, check out these free graphs here.

What Does the ROCE Trend For Compumedics Tell Us?

In terms of Compumedics' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 7.0% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Compumedics to turn into a multi-bagger.

On a side note, Compumedics' current liabilities have increased over the last five years to 42% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 4.1%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In summary, it's unfortunate that Compumedics is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 57% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Compumedics (including 1 which is a bit concerning) .

While Compumedics isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.