To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, S.S. Lazio (BIT:SSL) we aren't filled with optimism, but let's investigate further.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for S.S. Lazio:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.075 = €8.5m ÷ (€324m - €210m) (Based on the trailing twelve months to December 2020).
Thus, S.S. Lazio has an ROCE of 7.5%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 11%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for S.S. Lazio's ROCE against it's prior returns. If you're interested in investigating S.S. Lazio's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For S.S. Lazio Tell Us?
We are a bit worried about the trend of returns on capital at S.S. Lazio. About five years ago, returns on capital were 16%, 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 S.S. Lazio becoming one if things continue as they have.
On a side note, S.S. Lazio's current liabilities have increased over the last five years to 65% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 7.5%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Bottom Line
In summary, it's unfortunate that S.S. Lazio is generating lower returns from the same amount of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 173%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
S.S. Lazio does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those make us uncomfortable...
While S.S. Lazio 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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