Returns On Capital Signal Difficult Times Ahead For Gulf Marine Services (LON:GMS)

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Gulf Marine Services (LON:GMS), the trends above didn't look too great.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Gulf Marine Services is:

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

0.036 = US$21m ÷ (US$654m - US$61m) (Based on the trailing twelve months to December 2020).

So, Gulf Marine Services has an ROCE of 3.6%. Even though it's in line with the industry average of 3.6%, it's still a low return by itself.

See our latest analysis for Gulf Marine Services

Above you can see how the current ROCE for Gulf Marine Services 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 Gulf Marine Services here for free.

What Can We Tell From Gulf Marine Services' ROCE Trend?

The trend of returns that Gulf Marine Services is generating are raising some concerns. The company used to generate 14% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 27% over that same period. 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

The Bottom Line On Gulf Marine Services' ROCE

In summary, it's unfortunate that Gulf Marine Services is shrinking its capital base and also generating lower returns. Unsurprisingly then, the stock has dived 88% over the last five years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we found 3 warning signs for Gulf Marine Services (2 are a bit unpleasant) you should be aware of.

While Gulf Marine Services 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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