Capital Allocation Trends At LivaNova (NASDAQ:LIVN) Aren't Ideal

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into LivaNova (NASDAQ:LIVN), we weren't too upbeat about how things were going.

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. Analysts use this formula to calculate it for LivaNova:

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

0.034 = US$51m ÷ (US$2.2b - US$697m) (Based on the trailing twelve months to December 2021).

Therefore, LivaNova has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 8.3%.

View our latest analysis for LivaNova

Above you can see how the current ROCE for LivaNova 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 LivaNova.

What The Trend Of ROCE Can Tell Us

In terms of LivaNova's historical ROCE trend, it isn't fantastic. Unfortunately, returns have declined substantially over the last five years to the 3.4% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 25% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, LivaNova's current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.4%. 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.

Our Take On LivaNova's ROCE

In summary, it's unfortunate that LivaNova is shrinking its capital base and also generating lower returns. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 61% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

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

While LivaNova isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.