When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, AgroFresh Solutions (NASDAQ:AGFS) we aren't filled with optimism, but let's investigate further.
What is 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. To calculate this metric for AgroFresh Solutions, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.015 = US$11m ÷ (US$786m - US$52m) (Based on the trailing twelve months to December 2020).
Thus, AgroFresh Solutions has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 7.2%.
Above you can see how the current ROCE for AgroFresh Solutions 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 AgroFresh Solutions.
What The Trend Of ROCE Can Tell Us
We aren't inspired by the trend, given ROCE has reduced by 58% over the last five years and AgroFresh Solutions is applying -28% less capital in the business, even after the capital raising they conducted (prior to their latest reported figures).
The Key Takeaway
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 60% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 2 warning signs facing AgroFresh Solutions that you might find interesting.
While AgroFresh Solutions 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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