If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into Louis (CSE:LUI), 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. To calculate this metric for Louis, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.056 = €16m ÷ (€313m - €28m) (Based on the trailing twelve months to December 2023).
So, Louis has an ROCE of 5.6%. Ultimately, that's a low return and it under-performs the Hospitality industry average of 7.7%.
View our latest analysis for Louis
Historical performance is a great place to start when researching a stock so above you can see the gauge for Louis' ROCE against it's prior returns. If you're interested in investigating Louis' past further, check out this free graph covering Louis' past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Louis. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Louis to turn into a multi-bagger.
The Bottom Line On Louis' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 50% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to know some of the risks facing Louis we've found 4 warning signs (3 shouldn't be ignored!) that you should be aware of before investing here.
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.
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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.
