When researching a stock for investment, what can tell us that the company is 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. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at Azkoyen (BME:AZK), so let's see why.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Azkoyen:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.08 = €10m ÷ (€160m - €34m) (Based on the trailing twelve months to December 2020).
So, Azkoyen has an ROCE of 8.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.9%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Azkoyen's ROCE against it's prior returns. If you'd like to look at how Azkoyen has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Azkoyen, given the returns are trending downwards. About five years ago, returns on capital were 11%, 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. 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. If these trends continue, we wouldn't expect Azkoyen to turn into a multi-bagger.
The Bottom Line On Azkoyen's ROCE
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 66% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
On a separate note, we've found 1 warning sign for Azkoyen you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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