Endesa (BME:ELE) Could Be Struggling To Allocate Capital

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Endesa (BME:ELE), 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. The formula for this calculation on Endesa is:

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

0.046 = €1.3b ÷ (€40b - €13b) (Based on the trailing twelve months to March 2024).

So, Endesa has an ROCE of 4.6%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 7.5%.

View our latest analysis for Endesa

Above you can see how the current ROCE for Endesa compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Endesa for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Endesa, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 7.5% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Endesa becoming one if things continue as they have.

What We Can Learn From Endesa's ROCE

In summary, it's unfortunate that Endesa is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 6.0% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Endesa does have some risks, we noticed 4 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Endesa isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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