What financial metrics can indicate to us that a company is maturing or even in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after glancing at the trends within L.B. Foster (NASDAQ:FSTR), we weren't too hopeful.
Understanding 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 L.B. Foster, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.045 = US$12m ÷ (US$379m - US$99m) (Based on the trailing twelve months to September 2020).
Thus, L.B. Foster has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.5%.
In the above chart we have measured L.B. Foster's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering L.B. Foster here for free.
How Are Returns Trending?
In terms of L.B. Foster's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 7.3% five years ago but has since fallen to 4.5%. In addition to that, L.B. Foster is now employing 46% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 26%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
Our Take On L.B. Foster's ROCE
To see L.B. Foster reducing the capital employed in the business in tandem with diminishing returns, is concerning. Investors must expect better things on the horizon though because the stock has risen 38% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Like most companies, L.B. Foster does come with some risks, and we've found 1 warning sign that you should be aware of.
While L.B. Foster isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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.
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