Capital Allocation Trends At NuVasive (NASDAQ:NUVA) Aren't Ideal

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. 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 NuVasive (NASDAQ:NUVA), the trends above didn't look too great.

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 NuVasive, this is the formula:

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

0.057 = US$84m ÷ (US$2.2b - US$697m) (Based on the trailing twelve months to September 2022).

Thus, NuVasive has an ROCE of 5.7%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 11%.

View our latest analysis for NuVasive

In the above chart we have measured NuVasive's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

There is reason to be cautious about NuVasive, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 8.4% that they were earning five years ago. 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 NuVasive to turn into a multi-bagger.

On a side note, NuVasive'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 5.7%. 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.

The Bottom Line On NuVasive's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 31% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

NuVasive does have some risks though, and we've spotted 1 warning sign for NuVasive that you might be interested in.

While NuVasive may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.