What underlying fundamental trends can indicate that a company might be in decline? 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Prime People (LON:PRP) we aren't filled with optimism, but let's investigate further.
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 Prime People is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.012 = UK£132k ÷ (UK£15m - UK£3.8m) (Based on the trailing twelve months to September 2021).
Thus, Prime People has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Prime People's ROCE against it's prior returns. If you'd like to look at how Prime People has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Prime People Tell Us?
We are a bit anxious about the trends of ROCE at Prime People. To be more specific, today's ROCE was 13% five years ago but has since fallen to 1.2%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 24% over that same period. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 26%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.2%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
What We Can Learn From Prime People's ROCE
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 12% 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.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Prime People (of which 1 is significant!) that you should know about.
While Prime People isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
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