Petards Group (LON:PEG) May Have Issues Allocating Its Capital

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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Petards Group (LON:PEG), we weren't too hopeful.

What Is 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 Petards Group is:

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

0.027 = UK£225k ÷ (UK£12m - UK£3.2m) (Based on the trailing twelve months to December 2022).

Thus, Petards Group has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Software industry average of 9.3%.

View our latest analysis for Petards Group

Above you can see how the current ROCE for Petards Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Petards Group.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Petards Group, given the returns are trending downwards. About five years ago, returns on capital were 12%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Petards Group to turn into a multi-bagger.

On a related note, Petards Group has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Petards Group's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. We expect this has contributed to the stock plummeting 76% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 2 warning signs for Petards Group you'll probably want to know about.

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.