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. And from a first read, things don't look too good at Crown Crafts (NASDAQ:CRWS), so let's see why.
Understanding 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 Crown Crafts, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$9.5m ÷ (US$66m - US$17m) (Based on the trailing twelve months to December 2020).
Therefore, Crown Crafts has an ROCE of 20%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 15% it's much better.
Above you can see how the current ROCE for Crown Crafts compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Crown Crafts.
What Does the ROCE Trend For Crown Crafts Tell Us?
There is reason to be cautious about Crown Crafts, given the returns are trending downwards. About five years ago, returns on capital were 27%, however they're now substantially lower than that as we saw above. 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 Crown Crafts to turn into a multi-bagger.
The Bottom Line On Crown Crafts' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 20% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you'd like to know more about Crown Crafts, we've spotted 3 warning signs, and 1 of them can't be ignored.
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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