What underlying fundamental trends can indicate that a company might be in decline? 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. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Flexsteel Industries (NASDAQ:FLXS), the trends above didn't look too great.
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. To calculate this metric for Flexsteel Industries, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0005 = US$90k ÷ (US$236m - US$58m) (Based on the trailing twelve months to December 2020).
Thus, Flexsteel Industries has an ROCE of 0.05%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 14%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Flexsteel Industries' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of Flexsteel Industries' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 18%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Flexsteel Industries 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. Long term shareholders who've owned the stock over the last five years have experienced a 11% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Flexsteel Industries does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...
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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What are the risks and opportunities for Flexsteel Industries?
Trading at 61.2% below our estimate of its fair value
Earnings are forecast to grow 129.37% per year
No risks detected for FLXS from our risks checks.
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Flexsteel Industries, Inc., together with its subsidiaries, operates as a manufacturer, importer, and online marketer of upholstered furniture for residential and contract markets in the United States.
Undervalued with adequate balance sheet.