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. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Dow (NYSE:DOW) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
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 Dow, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = US$2.9b ÷ (US$60b - US$11b) (Based on the trailing twelve months to March 2021).
Thus, Dow has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 8.2%.
Above you can see how the current ROCE for Dow compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Dow here for free.
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at Dow. About two years ago, returns on capital were 8.6%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 two years. If these trends continue, we wouldn't expect Dow to turn into a multi-bagger.
The Key Takeaway
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. However the stock has delivered a 56% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to continue researching Dow, you might be interested to know about the 2 warning signs that our analysis has discovered.
While Dow 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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