Zespól Elektrowni Patnów-Adamów-Konin (WSE:ZEP) Could Be Struggling To Allocate Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. On that note, looking into Zespól Elektrowni Patnów-Adamów-Konin (WSE:ZEP), we weren't too upbeat about how things were going.

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

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 Zespól Elektrowni Patnów-Adamów-Konin is:

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

0.023 = zł36m ÷ (zł3.8b - zł2.2b) (Based on the trailing twelve months to March 2022).

So, Zespól Elektrowni Patnów-Adamów-Konin has an ROCE of 2.3%. In absolute terms, that's a low return and it also under-performs the Electric Utilities industry average of 9.4%.

See our latest analysis for Zespól Elektrowni Patnów-Adamów-Konin

In the above chart we have measured Zespól Elektrowni Patnów-Adamów-Konin's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

In terms of Zespól Elektrowni Patnów-Adamów-Konin's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 9.3% five years ago but has since fallen to 2.3%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 55% 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, Zespól Elektrowni Patnów-Adamów-Konin's current liabilities have increased over the last five years to 58% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.3%. 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 Bottom Line

In summary, it's unfortunate that Zespól Elektrowni Patnów-Adamów-Konin is shrinking its capital base and also generating lower returns. Yet despite these concerning fundamentals, the stock has performed strongly with a 96% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 1 warning sign with Zespól Elektrowni Patnów-Adamów-Konin and understanding it should be part of your investment process.

While Zespól Elektrowni Patnów-Adamów-Konin 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.