If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount 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. And from a first read, things don't look too good at Visteon (NASDAQ:VC), so let's see why.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for Visteon, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = US$90m ÷ (US$2.2b - US$775m) (Based on the trailing twelve months to March 2021).
Therefore, Visteon has an ROCE of 6.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 11%.
In the above chart we have measured Visteon'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
We are a bit worried about the trend of returns on capital at Visteon. About five years ago, returns on capital were 14%, 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 Visteon to turn into a multi-bagger.
Our Take On Visteon's ROCE
In summary, it's unfortunate that Visteon is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 56% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Visteon does have some risks though, and we've spotted 1 warning sign for Visteon that you might be interested in.
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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