Espey Mfg. & Electronics (NYSEMKT:ESP) Will Be Looking To Turn Around Its Returns

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. In light of that, from a first glance at Espey Mfg. & Electronics (NYSEMKT:ESP), we've spotted some signs that it could be struggling, so let's investigate.

What is 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. To calculate this metric for Espey Mfg. & Electronics, this is the formula:

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

0.029 = US$870k ÷ (US$37m - US$6.5m) (Based on the trailing twelve months to December 2020).

Therefore, Espey Mfg. & Electronics has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Electrical industry average of 9.0%.

View our latest analysis for Espey Mfg. & Electronics

Historical performance is a great place to start when researching a stock so above you can see the gauge for Espey Mfg. & Electronics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Espey Mfg. & Electronics, check out these free graphs here.

So How Is Espey Mfg. & Electronics' ROCE Trending?

We are a bit worried about the trend of returns on capital at Espey Mfg. & Electronics. To be more specific, the ROCE was 13% 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. 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 Espey Mfg. & Electronics becoming one if things continue as they have.

On a side note, Espey Mfg. & Electronics' current liabilities have increased over the last five years to 18% of total assets, effectively distorting the ROCE to some degree. 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.

The Bottom Line On Espey Mfg. & Electronics' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 20% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Espey Mfg. & Electronics does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

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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