When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into PULSION Medical Systems (MUN:PUS), the trends above didn't look too great.
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. To calculate this metric for PULSION Medical Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = €4.8m ÷ (€31m - €6.6m) (Based on the trailing twelve months to December 2019).
Therefore, PULSION Medical Systems has an ROCE of 20%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 12% it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for PULSION Medical Systems' ROCE against it's prior returns. If you'd like to look at how PULSION Medical Systems has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
The trend of returns that PULSION Medical Systems is generating are raising some concerns. To be more specific, today's ROCE was 26% five years ago but has since fallen to 20%. On top of that, the business is utilizing 26% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 21%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 20%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors must expect better things on the horizon though because the stock has risen 3.0% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
On a final note, we've found 1 warning sign for PULSION Medical Systems that we think you should be aware of.
While PULSION Medical Systems 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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