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 the company is producing less profit from its investments and its total assets are decreasing. And from a first read, things don't look too good at Nemak S. A. B. de C. V (BMV:NEMAKA), so let's see why.
Understanding 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 Nemak S. A. B. de C. V:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.087 = Mex$5.8b ÷ (Mex$99b - Mex$32b) (Based on the trailing twelve months to September 2021).
So, Nemak S. A. B. de C. V has an ROCE of 8.7%. Even though it's in line with the industry average of 8.9%, it's still a low return by itself.
Above you can see how the current ROCE for Nemak S. A. B. de C. V compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Nemak S. A. B. de C. V here for free.
How Are Returns Trending?
In terms of Nemak S. A. B. de C. V's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. 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 Nemak S. A. B. de C. V becoming one if things continue as they have.
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. Investors haven't taken kindly to these developments, since the stock has declined 68% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing Nemak S. A. B. de C. V we've found 4 warning signs (1 is a bit concerning!) that you should be aware of before investing here.
While Nemak S. A. B. de C. V 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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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.