What financial metrics can indicate to us that a company is maturing or even in decline? 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into South32 (ASX:S32), we weren't too upbeat about how things were going.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on South32 is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0022 = US$28m ÷ (US$14b - US$1.5b) (Based on the trailing twelve months to December 2020).
So, South32 has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 8.3%.
Above you can see how the current ROCE for South32 compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for South32.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at South32. About five years ago, returns on capital were 2.2%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect South32 to turn into a multi-bagger.
Our Take On South32's ROCE
In summary, it's unfortunate that South32 is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 70% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
South32 could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
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.
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