What AJ Networks' (KRX:095570) Returns On Capital Can Tell Us

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at AJ Networks (KRX:095570), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on AJ Networks is:

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

0.023 = ₩22b ÷ (₩1.7t - ₩759b) (Based on the trailing twelve months to September 2020).

Thus, AJ Networks has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 4.4%.

View our latest analysis for AJ Networks

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

What Does the ROCE Trend For AJ Networks Tell Us?

We are a bit worried about the trend of returns on capital at AJ Networks. To be more specific, the ROCE was 8.0% five years ago, but since then it has dropped noticeably. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on AJ Networks becoming one if things continue as they have.

On a separate but related note, it's important to know that AJ Networks has a current liabilities to total assets ratio of 44%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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. Long term shareholders who've owned the stock over the last five years have experienced a 46% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

AJ Networks does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

While AJ Networks 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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