Highlight Communications (ETR:HLG) Could Be Struggling To Allocate Capital

What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Highlight Communications (ETR:HLG), we've spotted some signs that it could be struggling, so let's investigate.

Understanding 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 Highlight Communications, this is the formula:

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

0.035 = CHF7.1m ÷ (CHF641m - CHF436m) (Based on the trailing twelve months to June 2024).

Therefore, Highlight Communications has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 12%.

See our latest analysis for Highlight Communications

In the above chart we have measured Highlight Communications' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Highlight Communications .

What Does the ROCE Trend For Highlight Communications Tell Us?

The trend of ROCE at Highlight Communications is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 3.5% we see today. On top of that, the business is utilizing 29% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Highlight Communications' current liabilities have increased over the last five years to 68% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In summary, it's unfortunate that Highlight Communications is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 63% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to know some of the risks facing Highlight Communications we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Highlight Communications 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.