Engie Energia Chile (SNSE:ECL) Has Some Difficulty Using Its Capital Effectively

When researching a stock for investment, what can tell us that the company is in decline? 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Engie Energia Chile (SNSE:ECL), so let's see why.

What Is 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. To calculate this metric for Engie Energia Chile, this is the formula:

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

0.0021 = US$7.3m ÷ (US$4.2b - US$636m) (Based on the trailing twelve months to June 2022).

So, Engie Energia Chile has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 10%.

Check out our latest analysis for Engie Energia Chile

In the above chart we have measured Engie Energia Chile's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

In terms of Engie Energia Chile's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 4.5%, 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. 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 Engie Energia Chile to turn into a multi-bagger.

The Bottom Line On Engie Energia Chile's ROCE

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. It should come as no surprise then that the stock has fallen 52% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Engie Energia Chile (at least 1 which is significant) , and understanding these would certainly be useful.

While Engie Energia Chile 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.