Sapphire (SGX:BRD) Could Be At Risk Of Shrinking As A Company

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. 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 Sapphire (SGX:BRD), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

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 Sapphire:

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

0.023 = CN¥16m ÷ (CN¥717m - CN¥48m) (Based on the trailing twelve months to June 2022).

So, Sapphire has an ROCE of 2.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 1.6%.

See our latest analysis for Sapphire

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sapphire's ROCE against it's prior returns. If you're interested in investigating Sapphire's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Sapphire's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Sapphire becoming one if things continue as they have.

On a related note, Sapphire has decreased its current liabilities to 6.7% of total assets. Since the ratio used to be 64%, that's a significant reduction and it no doubt explains the drop in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 68% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 3 warning signs with Sapphire (at least 2 which can't be ignored) , and understanding these would certainly be useful.

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.