Some Investors May Be Worried About Argan's (NYSE:AGX) Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Argan (NYSE:AGX), we've spotted some signs that it could be struggling, so let's investigate.

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 Argan, this is the formula:

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

0.15 = US$42m ÷ (US$489m - US$203m) (Based on the trailing twelve months to January 2023).

So, Argan has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 12% generated by the Construction industry.

View our latest analysis for Argan

In the above chart we have measured Argan'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.

SWOT Analysis for Argan

What Can We Tell From Argan's ROCE Trend?

We are a bit anxious about the trends of ROCE at Argan. To be more specific, today's ROCE was 30% five years ago but has since fallen to 15%. On top of that, the business is utilizing 20% less capital within its operations. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Argan's current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To see Argan reducing the capital employed in the business in tandem with diminishing returns, is concerning. Yet despite these concerning fundamentals, the stock has performed strongly with a 45% 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.

On a separate note, we've found 1 warning sign for Argan you'll probably want to know about.

While Argan 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.