When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Southern Cross Media Group (ASX:SXL), so let's see why.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Southern Cross Media Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = AU$81m ÷ (AU$1.5b - AU$120m) (Based on the trailing twelve months to December 2020).
Thus, Southern Cross Media Group has an ROCE of 5.8%. In absolute terms, that's a low return, but it's much better than the Media industry average of 2.8%.
Above you can see how the current ROCE for Southern Cross Media Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Southern Cross Media Group Tell Us?
There is reason to be cautious about Southern Cross Media Group, given the returns are trending downwards. To be more specific, the ROCE was 9.2% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Southern Cross Media Group to turn into a multi-bagger.
The Bottom Line On Southern Cross Media Group's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. We expect this has contributed to the stock plummeting 74% during the last five years. 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 2 warning signs with Southern Cross Media Group and understanding them should be part of your investment process.
While Southern Cross Media Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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