Empresaria Group's (LON:EMR) Returns On Capital Tell Us There Is Reason To Feel Uneasy

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Empresaria Group (LON:EMR), we've spotted some signs that it could be struggling, so let's investigate.

Understanding 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. To calculate this metric for Empresaria Group, this is the formula:

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

0.094 = UK£5.7m ÷ (UK£116m - UK£55m) (Based on the trailing twelve months to June 2023).

Thus, Empresaria Group has an ROCE of 9.4%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 15%.

See our latest analysis for Empresaria Group

Above you can see how the current ROCE for Empresaria Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Empresaria Group here for free.

The Trend Of ROCE

In terms of Empresaria Group's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 18%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Empresaria Group becoming one if things continue as they have.

On a side note, Empresaria Group has done well to pay down its current liabilities to 48% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Key Takeaway

In summary, it's unfortunate that Empresaria Group is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 55% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Empresaria Group does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is significant...

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.