Napatech (OB:NAPA) Will Be Looking To Turn Around Its Returns

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Napatech (OB:NAPA), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Napatech is:

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

0.011 = kr.1.5m ÷ (kr.180m - kr.44m) (Based on the trailing twelve months to June 2022).

So, Napatech has an ROCE of 1.1%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 10%.

Check out our latest analysis for Napatech

Above you can see how the current ROCE for Napatech compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Napatech Tell Us?

In terms of Napatech's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 6.7% five years ago but has since fallen to 1.1%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 41% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 25%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.1%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Napatech's ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 32% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Napatech (1 is concerning) you should be aware of.

While Napatech 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.