Here's What's Concerning About Lechwerke's (FRA:LEC) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Lechwerke (FRA:LEC), so let's see why.

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 Lechwerke, this is the formula:

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

0.035 = €23m ÷ (€1.8b - €1.1b) (Based on the trailing twelve months to December 2021).

Therefore, Lechwerke has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 8.5%.

See our latest analysis for Lechwerke

Historical performance is a great place to start when researching a stock so above you can see the gauge for Lechwerke's ROCE against it's prior returns. If you'd like to look at how Lechwerke has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Lechwerke's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 16%, 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Lechwerke becoming one if things continue as they have.

Another thing to note, Lechwerke has a high ratio of current liabilities to total assets of 63%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Lechwerke's ROCE

In summary, it's unfortunate that Lechwerke is generating lower returns from the same amount of capital. Since the stock has skyrocketed 103% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 1 warning sign for Lechwerke that we think you should be aware of.

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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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.