CTEK (STO:CTEK) Could Be Struggling To Allocate Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. In light of that, from a first glance at CTEK (STO:CTEK), we've spotted some signs that it could be struggling, so let's investigate.

What Is Return On Capital Employed (ROCE)?

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 CTEK is:

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

0.034 = kr44m ÷ (kr1.7b - kr415m) (Based on the trailing twelve months to December 2022).

Therefore, CTEK has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Electrical industry average of 15%.

View our latest analysis for CTEK

In the above chart we have measured CTEK'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.

The Trend Of ROCE

There is reason to be cautious about CTEK, given the returns are trending downwards. About four years ago, returns on capital were 8.9%, 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. If these trends continue, we wouldn't expect CTEK to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 24%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.4%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From CTEK's ROCE

In summary, it's unfortunate that CTEK is generating lower returns from the same amount of capital. Unsurprisingly then, the stock has dived 79% over the last year, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

CTEK does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are concerning...

While CTEK 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.