What financial metrics can indicate to us that a company is maturing or even 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Traton (ETR:8TRA), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What is it?
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 Traton, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.02 = €513m ÷ (€41b - €15b) (Based on the trailing twelve months to September 2020).
Thus, Traton has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.3%.
In the above chart we have measured Traton's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Traton here for free.
How Are Returns Trending?
In terms of Traton's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 6.0% three years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Traton 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. Yet despite these concerning fundamentals, the stock has performed strongly with a 13% return over the last year, 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.
One final note, you should learn about the 4 warning signs we've spotted with Traton (including 1 which makes us a bit uncomfortable) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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