To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Asbestos (CVE:AB.H), 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. Analysts use this formula to calculate it for Asbestos:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0059 = CA$165k ÷ (CA$31m - CA$3.3m) (Based on the trailing twelve months to September 2022).
Thus, Asbestos has an ROCE of 0.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 1.5%.
See our latest analysis for Asbestos
Historical performance is a great place to start when researching a stock so above you can see the gauge for Asbestos' ROCE against it's prior returns. If you'd like to look at how Asbestos has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
SWOT Analysis for Asbestos
- No major strengths identified for AB.H.
- Interest payments on debt are not well covered.
- Has sufficient cash runway for more than 3 years based on current free cash flows.
- Lack of analyst coverage makes it difficult to determine AB.H's earnings prospects.
- Debt is not well covered by operating cash flow.
- Total liabilities exceed total assets, which raises the risk of financial distress.
The Trend Of ROCE
In terms of Asbestos' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 1.9%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Asbestos becoming one if things continue as they have.
On a side note, Asbestos has done well to pay down its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In Conclusion...
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. Yet despite these concerning fundamentals, the stock has performed strongly with a 43% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Asbestos does come with some risks though, we found 6 warning signs in our investment analysis, and 5 of those shouldn't be ignored...
While Asbestos 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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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 TSXV:AB.H
Medium-low and overvalued.
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