Viavi Solutions (NASDAQ:VIAV) Could Be Struggling To Allocate Capital

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. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Viavi Solutions (NASDAQ:VIAV), so let's see why.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Viavi Solutions:

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

0.019 = US$29m ÷ (US$1.7b - US$228m) (Based on the trailing twelve months to March 2024).

So, Viavi Solutions has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 8.0%.

Check out our latest analysis for Viavi Solutions

In the above chart we have measured Viavi Solutions' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Viavi Solutions .

What Does the ROCE Trend For Viavi Solutions Tell Us?

We are a bit worried about the trend of returns on capital at Viavi Solutions. About five years ago, returns on capital were 3.6%, 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. 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 Viavi Solutions to turn into a multi-bagger.

The Bottom Line On Viavi Solutions' ROCE

In summary, it's unfortunate that Viavi Solutions is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 45% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Viavi Solutions does have some risks though, and we've spotted 1 warning sign for Viavi Solutions that you might be interested in.

While Viavi 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.