Precision Camshafts (NSE:PRECAM) Will Be Hoping To Turn Its Returns On Capital Around

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Precision Camshafts (NSE:PRECAM), we weren't too hopeful.

What Is 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 Precision Camshafts is:

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

0.041 = ₹312m ÷ (₹11b - ₹3.5b) (Based on the trailing twelve months to June 2023).

Therefore, Precision Camshafts has an ROCE of 4.1%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 14%.

View our latest analysis for Precision Camshafts

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're interested in investigating Precision Camshafts' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Precision Camshafts, given the returns are trending downwards. To be more specific, the ROCE was 5.5% five years ago, but since then it has dropped noticeably. 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 Precision Camshafts becoming one if things continue as they have.

On a side note, Precision Camshafts' current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 4.1%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line On Precision Camshafts' 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. Yet despite these poor fundamentals, the stock has gained a huge 339% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Precision Camshafts (including 1 which is significant) .

While Precision Camshafts 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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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.