ADT (NYSE:ADT) Could Be Struggling To Allocate Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into ADT (NYSE:ADT), we weren't too upbeat about how things were going.

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. Analysts use this formula to calculate it for ADT:

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

0.0081 = US$126m ÷ (US$17b - US$1.6b) (Based on the trailing twelve months to March 2022).

Thus, ADT has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Consumer Services industry average of 6.1%.

See our latest analysis for ADT

In the above chart we have measured ADT's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for ADT.

What Can We Tell From ADT's ROCE Trend?

There is reason to be cautious about ADT, given the returns are trending downwards. About five years ago, returns on capital were 1.2%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect ADT to turn into a multi-bagger.

The Bottom Line

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. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 30% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

ADT does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.