What underlying fundamental trends can indicate that a company might be in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Equital (TLV:EQTL), we weren't too upbeat about how things were going.
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 Equital is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.08 = ₪1.5b ÷ (₪20b - ₪2.2b) (Based on the trailing twelve months to June 2021).
So, Equital has an ROCE of 8.0%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 13%.
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'd like to look at how Equital has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Equital's ROCE Trend?
We are a bit worried about the trend of returns on capital at Equital. To be more specific, the ROCE was 12% five years ago, but since then it has dropped noticeably. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Equital becoming one if things continue as they have.
What We Can Learn From Equital's ROCE
In summary, it's unfortunate that Equital is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 52% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to know some of the risks facing Equital we've found 2 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
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.
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.
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