Nemak S. A. B. de C. V (BMV:NEMAKA) Is Finding It Tricky To Allocate Its Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Nemak S. A. B. de C. V (BMV:NEMAKA) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Nemak S. A. B. de C. V, this is the formula:

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

0.059 = Mex$3.8b ÷ (Mex$104b - Mex$39b) (Based on the trailing twelve months to September 2022).

Therefore, Nemak S. A. B. de C. V has an ROCE of 5.9%. Even though it's in line with the industry average of 6.3%, it's still a low return by itself.

Check out our latest analysis for Nemak S. A. B. de C. V

In the above chart we have measured Nemak S. A. B. de C. V's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Nemak S. A. B. de C. V's ROCE Trend?

We are a bit worried about the trend of returns on capital at Nemak S. A. B. de C. V. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Nemak S. A. B. de C. V to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 38%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.9%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Nemak S. A. B. de C. V's ROCE

In summary, it's unfortunate that Nemak S. A. B. de C. V is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 57% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with Nemak S. A. B. de C. V (at least 1 which is a bit concerning) , and understanding these would certainly be useful.

While Nemak S. A. B. de C. V 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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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.