What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at NZ Automotive Investments (NZSE:NZA), so let's see why.
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. To calculate this metric for NZ Automotive Investments, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = NZ$3.5m ÷ (NZ$38m - NZ$17m) (Based on the trailing twelve months to March 2022).
So, NZ Automotive Investments has an ROCE of 17%. That's a pretty standard return and it's in line with the industry average of 17%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating NZ Automotive Investments' past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
There is reason to be cautious about NZ Automotive Investments, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 26% that they were earning one year ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on NZ Automotive Investments becoming one if things continue as they have.
On a side note, NZ Automotive Investments' current liabilities are still rather high at 44% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
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 58% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know more about NZ Automotive Investments, we've spotted 5 warning signs, and 4 of them shouldn't be ignored.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.