Capital Allocation Trends At Escrit (TSE:2196) Aren't Ideal

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. 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, Escrit (TSE:2196) we aren't filled with optimism, but let's investigate further.

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. Analysts use this formula to calculate it for Escrit:

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

0.061 = JP¥930m ÷ (JP¥23b - JP¥8.0b) (Based on the trailing twelve months to March 2024).

Therefore, Escrit has an ROCE of 6.1%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 9.6%.

See our latest analysis for Escrit

Historical performance is a great place to start when researching a stock so above you can see the gauge for Escrit's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Escrit.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about Escrit, given the returns are trending downwards. About five years ago, returns on capital were 13%, 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 Escrit becoming one if things continue as they have.

The Bottom Line On Escrit's ROCE

In summary, it's unfortunate that Escrit is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 74% over the last five years, so investors are recognizing these changes and don't like the company's prospects. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Escrit does have some risks, we noticed 3 warning signs (and 1 which is concerning) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.

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