To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. And from a first read, things don't look too good at Oxford Metrics (LON:OMG), so let's see why.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Oxford Metrics:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = UK£1.7m ÷ (UK£46m - UK£10m) (Based on the trailing twelve months to September 2020).
Therefore, Oxford Metrics has an ROCE of 4.8%. In absolute terms, that's a low return and it also under-performs the Software industry average of 7.1%.
In the above chart we have measured Oxford Metrics' 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 The Trend Of ROCE Can Tell Us
In terms of Oxford Metrics' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 15%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Oxford Metrics to turn into a multi-bagger.
What We Can Learn From Oxford Metrics' ROCE
In summary, it's unfortunate that Oxford Metrics is generating lower returns from the same amount of capital. Since the stock has skyrocketed 136% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One final note, you should learn about the 3 warning signs we've spotted with Oxford Metrics (including 1 which is a bit unpleasant) .
While Oxford Metrics 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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