Investors Could Be Concerned With Asbestos' (CVE:AB.H) Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Asbestos (CVE:AB.H), we weren't too hopeful.

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. The formula for this calculation on Asbestos is:

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).

So, Asbestos has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 1.9%.

Check out the opportunities and risks within the CA Metals and Mining industry.

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.

What Does the ROCE Trend For Asbestos Tell Us?

We are a bit worried about the trend of returns on capital at Asbestos. Unfortunately the returns on capital have diminished from the 1.9% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Asbestos to turn into a multi-bagger.

On a related note, Asbestos has decreased its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, it's unfortunate that Asbestos is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 82% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 6 warning signs for Asbestos (of which 5 are significant!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.