If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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, E-SUPPORTLINK (TYO:2493) 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. The formula for this calculation on E-SUPPORTLINK is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = JP¥253m ÷ (JP¥5.5b - JP¥841m) (Based on the trailing twelve months to November 2020).
Thus, E-SUPPORTLINK has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the IT industry average of 13%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for E-SUPPORTLINK's ROCE against it's prior returns. If you're interested in investigating E-SUPPORTLINK's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is E-SUPPORTLINK's ROCE Trending?
There is reason to be cautious about E-SUPPORTLINK, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect E-SUPPORTLINK to turn into a multi-bagger.
The Bottom Line
In summary, it's unfortunate that E-SUPPORTLINK is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 34% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you want to know some of the risks facing E-SUPPORTLINK we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.
While E-SUPPORTLINK isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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