Be Wary Of Castings (LON:CGS) And Its Returns On Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Castings (LON:CGS), so let's see why.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Castings:

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

0.03 = UK£3.9m ÷ (UK£154m - UK£24m) (Based on the trailing twelve months to September 2020).

Thus, Castings has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 12%.

Check out our latest analysis for Castings

Above you can see how the current ROCE for Castings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Castings' ROCE Trending?

There is reason to be cautious about Castings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 15% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Castings becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 3.3% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we found 3 warning signs for Castings (1 shouldn't be ignored) you should be aware of.

While Castings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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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