If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Harley-Davidson (NYSE:HOG), we've spotted some signs that it could be struggling, so let's investigate.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Harley-Davidson, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = US$377m ÷ (US$11b - US$3.5b) (Based on the trailing twelve months to March 2021).
Thus, Harley-Davidson has an ROCE of 4.8%. In absolute terms, that's a low return and it also under-performs the Auto industry average of 9.4%.
Above you can see how the current ROCE for Harley-Davidson 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.
The Trend Of ROCE
In terms of Harley-Davidson's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 15% that they were earning five years ago. 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 Harley-Davidson to turn into a multi-bagger.
In summary, it's unfortunate that Harley-Davidson is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 17% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
One more thing: We've identified 4 warning signs with Harley-Davidson (at least 1 which is a bit unpleasant) , and understanding them would certainly be useful.
While Harley-Davidson 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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