Northrop Grumman (NYSE:NOC) May Have Issues Allocating Its Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Northrop Grumman (NYSE:NOC), so let's see why.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Northrop Grumman is:

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

0.081 = US$2.8b ÷ (US$48b - US$13b) (Based on the trailing twelve months to March 2024).

Thus, Northrop Grumman has an ROCE of 8.1%. In absolute terms, that's a low return but it's around the Aerospace & Defense industry average of 9.8%.

View our latest analysis for Northrop Grumman

Above you can see how the current ROCE for Northrop Grumman compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Northrop Grumman for free.

What The Trend Of ROCE Can Tell Us

In terms of Northrop Grumman's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 14% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Northrop Grumman to turn into a multi-bagger.

Our Take On Northrop Grumman's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 66% return. 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 2 warning signs for Northrop Grumman you'll probably want to know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.