Returns On Capital Tell Us A Lot About Cyanotech (NASDAQ:CYAN)

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. 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. So after we looked into Cyanotech (NASDAQ:CYAN), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Cyanotech:

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

0.026 = US$645k ÷ (US$33m - US$8.0m) (Based on the trailing twelve months to September 2020).

Therefore, Cyanotech has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Personal Products industry average of 16%.

Check out our latest analysis for Cyanotech

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Cyanotech's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of Cyanotech's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 6.7%, 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Cyanotech becoming one if things continue as they have.

Our Take On Cyanotech'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 40% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 5 warning signs with Cyanotech (at least 1 which is potentially serious) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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