Energoinstal (WSE:ENI) May Have Issues Allocating Its Capital

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 indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Energoinstal (WSE:ENI), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

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 Energoinstal:

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

0.015 = zł943k ÷ (zł114m - zł52m) (Based on the trailing twelve months to September 2021).

Therefore, Energoinstal has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 11%.

Check out our latest analysis for Energoinstal

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'd like to look at how Energoinstal has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Energoinstal Tell Us?

We are a bit anxious about the trends of ROCE at Energoinstal. To be more specific, today's ROCE was 7.1% five years ago but has since fallen to 1.5%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 62% 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Energoinstal's current liabilities are still rather high at 46% 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, it's unfortunate that Energoinstal is shrinking its capital base and also generating lower returns. Long term shareholders who've owned the stock over the last five years have experienced a 48% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to know some of the risks facing Energoinstal we've found 4 warning signs (2 are a bit unpleasant!) that you should be aware of before investing here.

While Energoinstal 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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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.