If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Sensient Technologies (NYSE:SXT), we weren't too upbeat about how things were going.
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. Analysts use this formula to calculate it for Sensient Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.098 = US$148m ÷ (US$1.7b - US$212m) (Based on the trailing twelve months to September 2020).
So, Sensient Technologies has an ROCE of 9.8%. In absolute terms, that's a low return but it's around the Chemicals industry average of 9.2%.
In the above chart we have measured Sensient Technologies' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sensient Technologies here for free.
How Are Returns Trending?
In terms of Sensient Technologies' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Sensient Technologies becoming one if things continue as they have.
The Key Takeaway
In summary, it's unfortunate that Sensient Technologies is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 18% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
Like most companies, Sensient Technologies does come with some risks, and we've found 4 warning signs that you should be aware of.
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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