Be Wary Of Johnson Matthey (LON:JMAT) And Its Returns On Capital

What financial metrics can indicate to us that a company is maturing or even in decline? 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 indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into Johnson Matthey (LON:JMAT), we weren't too upbeat about how things were going.

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 Johnson Matthey:

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

0.11 = UK£423m ÷ (UK£6.5b - UK£2.6b) (Based on the trailing twelve months to September 2023).

Thus, Johnson Matthey has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Chemicals industry average of 13%.

See our latest analysis for Johnson Matthey

In the above chart we have measured Johnson Matthey's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Johnson Matthey Tell Us?

There is reason to be cautious about Johnson Matthey, given the returns are trending downwards. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. 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. If these trends continue, we wouldn't expect Johnson Matthey to turn into a multi-bagger.

On a side note, Johnson Matthey's current liabilities have increased over the last five years to 39% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

In summary, it's unfortunate that Johnson Matthey is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 35% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 4 warning signs with Johnson Matthey and understanding them should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.