Gattaca (LON:GATC) Is Finding It Tricky To Allocate Its Capital

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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Gattaca (LON:GATC), we weren't too upbeat about how things were going.

What Is 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 Gattaca is:

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

0.064 = UK£2.1m ÷ (UK£81m - UK£49m) (Based on the trailing twelve months to July 2023).

Thus, Gattaca has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 15%.

Check out our latest analysis for Gattaca

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

The Trend Of ROCE

The trend of ROCE at Gattaca is showing some signs of weakness. To be more specific, today's ROCE was 15% five years ago but has since fallen to 6.4%. In addition to that, Gattaca is now employing 50% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a separate but related note, it's important to know that Gattaca has a current liabilities to total assets ratio of 60%, which we'd consider pretty high. 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.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors must expect better things on the horizon though because the stock has risen 11% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing, we've spotted 2 warning signs facing Gattaca that you might find interesting.

While Gattaca 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. 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.