Capital Allocation Trends At Profire Energy (NASDAQ:PFIE) Aren't Ideal

What underlying fundamental trends can indicate that a company might be 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. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Profire Energy (NASDAQ:PFIE), we've spotted some signs that it could be struggling, so let's investigate.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Profire Energy, this is the formula:

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

0.058 = US$2.6m ÷ (US$51m - US$5.8m) (Based on the trailing twelve months to September 2022).

So, Profire Energy has an ROCE of 5.8%. In absolute terms, that's a low return but it's around the Energy Services industry average of 7.0%.

Our analysis indicates that PFIE is potentially undervalued!

In the above chart we have measured Profire Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Profire Energy here for free.

So How Is Profire Energy's ROCE Trending?

In terms of Profire Energy's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Profire Energy to turn into a multi-bagger.

What We Can Learn From Profire Energy's 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 34% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 1 warning sign with Profire Energy and understanding it should be part of your investment process.

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.