Returns On Capital Signal Difficult Times Ahead For OPEN Group (TSE:6572)

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at OPEN Group (TSE:6572), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for OPEN Group:

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

0.037 = JP¥513m ÷ (JP¥20b - JP¥6.0b) (Based on the trailing twelve months to November 2024).

Therefore, OPEN Group has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Software industry average of 16%.

Check out our latest analysis for OPEN Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for OPEN Group's ROCE against it's prior returns. If you'd like to look at how OPEN Group has performed in the past in other metrics, you can view this free graph of OPEN Group's past earnings, revenue and cash flow.

How Are Returns Trending?

There is reason to be cautious about OPEN Group, given the returns are trending downwards. To be more specific, the ROCE was 4.8% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 OPEN Group to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 30%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On OPEN Group's 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. This could explain why the stock has sunk a total of 73% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about OPEN Group, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.

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.