Here's What's Concerning About Carlo Gavazzi Holding's (VTX:GAV) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 Carlo Gavazzi Holding (VTX:GAV), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Carlo Gavazzi Holding:

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

0.10 = CHF11m ÷ (CHF138m - CHF32m) (Based on the trailing twelve months to September 2020).

Therefore, Carlo Gavazzi Holding has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.

See our latest analysis for Carlo Gavazzi Holding

Above you can see how the current ROCE for Carlo Gavazzi Holding 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 Carlo Gavazzi Holding here for free.

So How Is Carlo Gavazzi Holding's ROCE Trending?

In terms of Carlo Gavazzi Holding's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 15% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Carlo Gavazzi Holding becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 9.1% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Carlo Gavazzi Holding (of which 1 makes us a bit uncomfortable!) that you should know about.

While Carlo Gavazzi Holding isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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