ForFarmers (AMS:FFARM) Could Be Struggling To Allocate Capital

What underlying fundamental trends can indicate that a company might be in decline? 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. So after glancing at the trends within ForFarmers (AMS:FFARM), we weren't too hopeful.

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

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 ForFarmers:

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

0.045 = €24m ÷ (€943m - €414m) (Based on the trailing twelve months to December 2021).

So, ForFarmers has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Food industry average of 8.3%.

See our latest analysis for ForFarmers

Above you can see how the current ROCE for ForFarmers compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for ForFarmers.

What Can We Tell From ForFarmers' ROCE Trend?

There is reason to be cautious about ForFarmers, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 12% that they were earning five years ago. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on ForFarmers becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 44%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.5%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 64% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

ForFarmers does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.