Zytronic (LON:ZYT) May Have Issues Allocating Its Capital

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Zytronic (LON:ZYT) we aren't filled with optimism, but let's investigate further.

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. The formula for this calculation on Zytronic is:

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

0.072 = UK£1.2m ÷ (UK£18m - UK£1.5m) (Based on the trailing twelve months to March 2022).

Therefore, Zytronic has an ROCE of 7.2%. Ultimately, that's a low return and it under-performs the Electronic industry average of 11%.

Check out our latest analysis for Zytronic

In the above chart we have measured Zytronic'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 Zytronic Tell Us?

In terms of Zytronic's historical ROCE trend, it isn't fantastic. The company used to generate 20% on its capital five years ago but it has since fallen noticeably. In addition to that, Zytronic is now employing 35% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. 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 Key Takeaway

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 68% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Zytronic does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should 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.