Valeo (EPA:FR) Could Be Struggling To Allocate Capital

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount 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.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Valeo, this is the formula:

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

0.069 = €693m ÷ (€21b - €10b) (Based on the trailing twelve months to June 2023).

Therefore, Valeo has an ROCE of 6.9%. On its own, that's a low figure but it's around the 7.6% average generated by the Auto Components industry.

Check out our latest analysis for Valeo

In the above chart we have measured Valeo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Valeo here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Valeo, given the returns are trending downwards. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. 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. If these trends continue, we wouldn't expect Valeo to turn into a multi-bagger.

Another thing to note, Valeo has a high ratio of current liabilities to total assets of 51%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Valeo's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 47% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Valeo, you might be interested to know about the 2 warning signs that our analysis has discovered.

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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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.