Returns On Capital At Lechwerke (FRA:LEC) Paint A Concerning Picture

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Lechwerke (FRA:LEC), we weren't too hopeful.

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. Analysts use this formula to calculate it for Lechwerke:

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

0.012 = €7.4m ÷ (€1.7b - €1.1b) (Based on the trailing twelve months to June 2021).

Thus, Lechwerke has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 7.2%.

View our latest analysis for Lechwerke

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Lechwerke's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Lechwerke Tell Us?

We are a bit anxious about the trends of ROCE at Lechwerke. Unfortunately, returns have declined substantially over the last five years to the 1.2% we see today. In addition to that, Lechwerke is now employing 57% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Lechwerke's current liabilities have increased over the last five years to 63% 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. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

In summary, it's unfortunate that Lechwerke is shrinking its capital base and also generating lower returns. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 128%. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.