The Returns On Capital At Eternit (BVMF:ETER3) Don't Inspire Confidence

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Eternit (BVMF:ETER3), we weren't too upbeat about how things were going.

Understanding 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. Analysts use this formula to calculate it for Eternit:

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

0.081 = R$32m ÷ (R$624m - R$226m) (Based on the trailing twelve months to September 2020).

So, Eternit has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 6.5% generated by the Basic Materials industry, it's much better.

View our latest analysis for Eternit

Historical performance is a great place to start when researching a stock so above you can see the gauge for Eternit's ROCE against it's prior returns. If you'd like to look at how Eternit has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Eternit Tell Us?

In terms of Eternit's historical ROCE trend, it isn't fantastic. The company used to generate 22% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 45% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 36%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Eternit's ROCE

To see Eternit reducing the capital employed in the business in tandem with diminishing returns, is concerning. Despite the concerning underlying trends, the stock has actually gained 34% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

If you want to know some of the risks facing Eternit we've found 4 warning signs (2 don't sit too well with us!) that you should be aware of before investing here.

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. 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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