Returns On Capital Signal Difficult Times Ahead For Stoneridge (NYSE:SRI)

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Stoneridge (NYSE:SRI), we weren't too upbeat about how things were going.

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. Analysts use this formula to calculate it for Stoneridge:

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

0.052 = US$16m ÷ (US$685m - US$384m) (Based on the trailing twelve months to June 2023).

So, Stoneridge has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 12%.

View our latest analysis for Stoneridge

Above you can see how the current ROCE for Stoneridge 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.

What Does the ROCE Trend For Stoneridge Tell Us?

We are a bit anxious about the trends of ROCE at Stoneridge. To be more specific, today's ROCE was 17% five years ago but has since fallen to 5.2%. In addition to that, Stoneridge is now employing 27% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 56%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.2%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

In summary, it's unfortunate that Stoneridge is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 33% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Stoneridge (of which 2 don't sit too well with us!) that you should know about.

While Stoneridge isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.