When researching a stock for investment, what can tell us that the company is 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at REN - Redes Energéticas Nacionais SGPS (ELI:RENE), we've spotted some signs that it could be struggling, so let's investigate.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on REN - Redes Energéticas Nacionais SGPS is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = €201m ÷ (€5.6b - €1.5b) (Based on the trailing twelve months to June 2022).
So, REN - Redes Energéticas Nacionais SGPS has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Integrated Utilities industry average of 6.1%.
Above you can see how the current ROCE for REN - Redes Energéticas Nacionais SGPS 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 The Trend Of ROCE Can Tell Us
There is reason to be cautious about REN - Redes Energéticas Nacionais SGPS, given the returns are trending downwards. About five years ago, returns on capital were 6.5%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on REN - Redes Energéticas Nacionais SGPS becoming one if things continue as they have.
The Bottom Line
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. However the stock has delivered a 45% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing to note, we've identified 2 warning signs with REN - Redes Energéticas Nacionais SGPS and understanding these should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.