Be Wary Of Adacel Technologies (ASX:ADA) And Its 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at Adacel Technologies (ASX:ADA), so let's see why.

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. Analysts use this formula to calculate it for Adacel Technologies:

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

0.26 = US$4.0m ÷ (US$23m - US$7.8m) (Based on the trailing twelve months to December 2022).

Thus, Adacel Technologies has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Software industry average of 12%.

See our latest analysis for Adacel Technologies

In the above chart we have measured Adacel Technologies' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Adacel Technologies' ROCE Trend?

There is reason to be cautious about Adacel Technologies, given the returns are trending downwards. About five years ago, returns on capital were 43%, 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. 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 Adacel Technologies becoming one if things continue as they have.

The Bottom Line On Adacel Technologies' 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. It should come as no surprise then that the stock has fallen 58% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to know some of the risks facing Adacel Technologies we've found 5 warning signs (3 are a bit concerning!) that you should be aware of before investing here.

Adacel Technologies is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.