When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Evrofarma (ATH:EVROF) we aren't filled with optimism, but let's investigate further.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Evrofarma is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = €1.7m ÷ (€46m - €11m) (Based on the trailing twelve months to December 2020).
Therefore, Evrofarma has an ROCE of 4.7%. In absolute terms, that's a low return but it's around the Food industry average of 4.4%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Evrofarma's ROCE against it's prior returns. If you're interested in investigating Evrofarma's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Evrofarma Tell Us?
There is reason to be cautious about Evrofarma, given the returns are trending downwards. About five years ago, returns on capital were 7.5%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Evrofarma becoming one if things continue as they have.
Our Take On Evrofarma's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 513%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing: We've identified 3 warning signs with Evrofarma (at least 1 which doesn't sit too well with us) , and understanding them would certainly be useful.
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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