What underlying fundamental trends can indicate that a company might be in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into AGL Energy (ASX:AGL), the trends above didn't look too great.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on AGL Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = AU$710m ÷ (AU$15b - AU$3.4b) (Based on the trailing twelve months to December 2023).
Therefore, AGL Energy has an ROCE of 6.4%. On its own that's a low return, but compared to the average of 5.2% generated by the Integrated Utilities industry, it's much better.
See our latest analysis for AGL Energy
Above you can see how the current ROCE for AGL Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering AGL Energy for free.
What Does the ROCE Trend For AGL Energy Tell Us?
We are a bit worried about the trend of returns on capital at AGL Energy. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 AGL Energy to turn into a multi-bagger.
Our Take On AGL Energy's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 44% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we've found 2 warning signs for AGL Energy that we think you should be aware of.
While AGL Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
About ASX:AGL
AGL Energy
Engages in the supply of energy and other essential services to residential, business, and wholesale customers in Australia.
Established dividend payer with adequate balance sheet.
