To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Metro Performance Glass (NZSE:MPG) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Metro Performance Glass is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = NZ$15m ÷ (NZ$243m - NZ$96m) (Based on the trailing twelve months to March 2021).
So, Metro Performance Glass has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 10%.
Above you can see how the current ROCE for Metro Performance Glass 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 Metro Performance Glass.
How Are Returns Trending?
The trend of returns that Metro Performance Glass is generating are raising some concerns. The company used to generate 14% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 27% 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 40%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 10%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Key Takeaway
In summary, it's unfortunate that Metro Performance Glass is shrinking its capital base and also generating lower returns. We expect this has contributed to the stock plummeting 72% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know about the risks facing Metro Performance Glass, we've discovered 1 warning sign that you should be aware of.
While Metro Performance Glass 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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