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. 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. In light of that, from a first glance at Aggreko (LON:AGK), we've spotted some signs that it could be struggling, so let's investigate.
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. Analysts use this formula to calculate it for Aggreko:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = UK£214m ÷ (UK£2.3b - UK£669m) (Based on the trailing twelve months to June 2020).
Thus, Aggreko has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Commercial Services industry average of 10% it's much better.
Above you can see how the current ROCE for Aggreko 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 Aggreko here for free.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Aggreko, given the returns are trending downwards. 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Aggreko becoming one if things continue as they have.
The Bottom Line On Aggreko's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 11% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know more about Aggreko, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.
While Aggreko 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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