A. O. Smith (NYSE:AOS) Will Be Looking To Turn Around Its Returns

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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. And from a first read, things don't look too good at A. O. Smith (NYSE:AOS), so let's see why.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on A. O. Smith is:

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

0.098 = US$239m ÷ (US$3.3b - US$896m) (Based on the trailing twelve months to March 2023).

So, A. O. Smith has an ROCE of 9.8%. In absolute terms, that's a low return and it also under-performs the Building industry average of 14%.

View our latest analysis for A. O. Smith

In the above chart we have measured A. O. Smith's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for A. O. Smith.

SWOT Analysis for A. O. Smith

The Trend Of ROCE

In terms of A. O. Smith's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 23% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on A. O. Smith becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors must expect better things on the horizon though because the stock has risen 20% in 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 spotted 2 warning signs facing A. O. Smith that you might find interesting.

While A. O. Smith 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.