These Return Metrics Don't Make Valeo (EPA:FR) Look Too Strong

When researching a stock for investment, what can tell us that the company is 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 to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Valeo (EPA:FR) we aren't filled with optimism, but let's investigate further.

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. The formula for this calculation on Valeo is:

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

0.053 = €511m ÷ (€20b - €10b) (Based on the trailing twelve months to June 2022).

So, Valeo has an ROCE of 5.3%. On its own, that's a low figure but it's around the 6.0% average generated by the Auto Components industry.

See our latest analysis for Valeo

Above you can see how the current ROCE for Valeo compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Valeo's ROCE Trending?

There is reason to be cautious about Valeo, given the returns are trending downwards. To be more specific, the ROCE was 16% five years ago, but since then it has dropped noticeably. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Valeo becoming one if things continue as they have.

On a separate but related note, it's important to know that Valeo has a current liabilities to total assets ratio of 52%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Valeo's ROCE

In summary, it's unfortunate that Valeo is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 68% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 3 warning signs for Valeo you'll probably want to know about.

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.