To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. 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 Zimmer Biomet Holdings (NYSE:ZBH), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Zimmer Biomet Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = US$963m ÷ (US$24b - US$2.6b) (Based on the trailing twelve months to December 2020).
Thus, Zimmer Biomet Holdings has an ROCE of 4.4%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 9.7%.
In the above chart we have measured Zimmer Biomet Holdings' 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.
What Does the ROCE Trend For Zimmer Biomet Holdings Tell Us?
We are a bit worried about the trend of returns on capital at Zimmer Biomet Holdings. To be more specific, the ROCE was 6.4% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Zimmer Biomet Holdings becoming one if things continue as they have.
What We Can Learn From Zimmer Biomet Holdings' ROCE
In summary, it's unfortunate that Zimmer Biomet Holdings is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 81% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you want to know some of the risks facing Zimmer Biomet Holdings we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.
While Zimmer Biomet Holdings 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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Zimmer Biomet Holdings
Zimmer Biomet Holdings, Inc., together with its subsidiaries, operates in the musculoskeletal healthcare business in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.
Adequate balance sheet with moderate growth potential.