Bodycote (LON:BOY) Is Finding It Tricky To Allocate Its 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? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Bodycote (LON:BOY), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Bodycote is:

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

0.10 = UK£87m ÷ (UK£1.1b - UK£282m) (Based on the trailing twelve months to June 2022).

Therefore, Bodycote has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 11%.

View our latest analysis for Bodycote

In the above chart we have measured Bodycote's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Bodycote Tell Us?

There is reason to be cautious about Bodycote, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Bodycote to turn into a multi-bagger.

What We Can Learn From Bodycote'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. Investors haven't taken kindly to these developments, since the stock has declined 35% 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 1 warning sign for Bodycote you'll probably want to know about.

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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.