When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Alcoa (NYSE:AA), we weren't too upbeat about how things were going.
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. To calculate this metric for Alcoa, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = US$371m ÷ (US$15b - US$2.8b) (Based on the trailing twelve months to December 2020).
So, Alcoa has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 9.4%.
In the above chart we have measured Alcoa'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.
What The Trend Of ROCE Can Tell Us
In terms of Alcoa's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 7.5% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Alcoa to turn into a multi-bagger.
What We Can Learn From Alcoa'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 41% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you'd like to know about the risks facing Alcoa, we've discovered 1 warning sign that you should be aware of.
While Alcoa isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
When trading Alcoa or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.