Here's What We Make Of Danieli & C. Officine Meccaniche's (BIT:DAN) Returns On Capital

What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Danieli & C. Officine Meccaniche (BIT:DAN), so let's see why.

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 Danieli & C. Officine Meccaniche, this is the formula:

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

0.047 = €105m ÷ (€5.1b - €2.8b) (Based on the trailing twelve months to June 2020).

Thus, Danieli & C. Officine Meccaniche has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.1%.

Check out our latest analysis for Danieli & C. Officine Meccaniche

In the above chart we have measured Danieli & C. Officine Meccaniche's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Danieli & C. Officine Meccaniche here for free.

What Does the ROCE Trend For Danieli & C. Officine Meccaniche Tell Us?

In terms of Danieli & C. Officine Meccaniche's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 7.0% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Danieli & C. Officine Meccaniche to turn into a multi-bagger.

On a separate but related note, it's important to know that Danieli & C. Officine Meccaniche has a current liabilities to total assets ratio of 56%, which we'd consider pretty high. 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.

In Conclusion...

In summary, it's unfortunate that Danieli & C. Officine Meccaniche is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 16% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 1 warning sign for Danieli & C. Officine Meccaniche that we think you should be aware of.

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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