Vesuvius (LON:VSVS) Is Finding It Tricky To Allocate Its Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at Vesuvius (LON:VSVS), so let's see why.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Vesuvius is:

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

0.054 = UK£91m ÷ (UK£2.0b - UK£369m) (Based on the trailing twelve months to December 2020).

Therefore, Vesuvius has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Machinery industry average of 8.7%.

Check out our latest analysis for Vesuvius

Above you can see how the current ROCE for Vesuvius 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 Vesuvius.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Vesuvius. To be more specific, the ROCE was 7.4% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Vesuvius becoming one if things continue as they have.

The Bottom Line

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. Yet despite these poor fundamentals, the stock has gained a huge 103% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 3 warning signs for Vesuvius that we think you should be aware of.

While Vesuvius 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. 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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