Visteon (NASDAQ:VC) Is Finding It Tricky To Allocate Its Capital

What underlying fundamental trends can indicate that a company might be in decline? 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. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Visteon (NASDAQ:VC) we aren't filled with optimism, but let's investigate further.

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 Visteon is:

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

0.14 = US$195m ÷ (US$2.3b - US$980m) (Based on the trailing twelve months to September 2022).

So, Visteon has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Auto Components industry.

See our latest analysis for Visteon

Above you can see how the current ROCE for Visteon compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Visteon here for free.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Visteon. Unfortunately the returns on capital have diminished from the 19% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Visteon to turn into a multi-bagger.

Another thing to note, Visteon has a high ratio of current liabilities to total assets of 42%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

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. Despite the concerning underlying trends, the stock has actually gained 6.6% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you want to know some of the risks facing Visteon we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Visteon 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.