Be Wary Of Methode Electronics (NYSE:MEI) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Methode Electronics (NYSE:MEI), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Methode Electronics:

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

0.045 = US$57m ÷ (US$1.5b - US$218m) (Based on the trailing twelve months to October 2023).

So, Methode Electronics has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Electronic industry average of 12%.

See our latest analysis for Methode Electronics

Above you can see how the current ROCE for Methode Electronics 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 Methode Electronics here for free.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Methode Electronics. About five years ago, returns on capital were 12%, 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Methode Electronics to turn into a multi-bagger.

What We Can Learn From Methode Electronics' ROCE

In summary, it's unfortunate that Methode Electronics 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 11% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we've found 1 warning sign for Methode Electronics that we think you should be aware of.

While Methode Electronics 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.