Detection Technology Oyj (HEL:DETEC) May Have Issues Allocating Its Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Detection Technology Oyj (HEL:DETEC) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Detection Technology Oyj, this is the formula:

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

0.15 = €9.3m ÷ (€81m - €17m) (Based on the trailing twelve months to June 2021).

So, Detection Technology Oyj has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 16% generated by the Electronic industry.

Check out our latest analysis for Detection Technology Oyj

Above you can see how the current ROCE for Detection Technology Oyj compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Detection Technology Oyj.

How Are Returns Trending?

In terms of Detection Technology Oyj's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 15% from 31% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Detection Technology Oyj has decreased its current liabilities to 21% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Detection Technology Oyj's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Detection Technology Oyj have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 163%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you're still interested in Detection Technology Oyj it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

While Detection Technology Oyj 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.
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