Capital Allocation Trends At Birman Wood & Hardware (TLV:BIRM) Aren't Ideal

What underlying fundamental trends can indicate that a company might be 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Birman Wood & Hardware (TLV:BIRM), the trends above didn't look too great.

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. To calculate this metric for Birman Wood & Hardware, this is the formula:

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

0.15 = ₪22m ÷ (₪318m - ₪175m) (Based on the trailing twelve months to December 2020).

So, Birman Wood & Hardware has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 17% generated by the Building industry.

See our latest analysis for Birman Wood & Hardware

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Birman Wood & Hardware, check out these free graphs here.

What Can We Tell From Birman Wood & Hardware's ROCE Trend?

In terms of Birman Wood & Hardware's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 19% that they were earning five years ago. 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 Birman Wood & Hardware to turn into a multi-bagger.

Another thing to note, Birman Wood & Hardware has a high ratio of current liabilities to total assets of 55%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

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. Despite the concerning underlying trends, the stock has actually gained 28% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Birman Wood & Hardware (of which 2 are concerning!) that you should know about.

While Birman Wood & Hardware 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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