Kennametal (NYSE:KMT) May Have Issues Allocating Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. 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 Kennametal (NYSE:KMT), we weren't too upbeat about how things were going.

Understanding 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 Kennametal, this is the formula:

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

0.097 = US$204m ÷ (US$2.6b - US$489m) (Based on the trailing twelve months to March 2023).

Thus, Kennametal has an ROCE of 9.7%. On its own, that's a low figure but it's around the 11% average generated by the Machinery industry.

Check out our latest analysis for Kennametal

In the above chart we have measured Kennametal'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 Kennametal here for free.

So How Is Kennametal's ROCE Trending?

There is reason to be cautious about Kennametal, given the returns are trending downwards. To be more specific, the ROCE was 13% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Kennametal to turn into a multi-bagger.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 10% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Kennametal and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.