Some Investors May Be Worried About Adbri's (ASX:ABC) Returns On Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Adbri (ASX:ABC) we aren't filled with optimism, but let's investigate further.

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. The formula for this calculation on Adbri is:

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

0.081 = AU$157m ÷ (AU$2.2b - AU$226m) (Based on the trailing twelve months to June 2021).

So, Adbri has an ROCE of 8.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.1%.

See our latest analysis for Adbri

In the above chart we have measured Adbri's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Adbri here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Adbri, given the returns are trending downwards. To be more specific, the ROCE was 14% 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Adbri becoming one if things continue as they have.

The Bottom Line

In summary, it's unfortunate that Adbri is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 30% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Adbri and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.