What underlying fundamental trends can indicate that a company might be in decline? 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. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Iridium Communications (NASDAQ:IRDM), the trends above didn't look too great.
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 Iridium Communications:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.01 = US$33m ÷ (US$3.3b - US$88m) (Based on the trailing twelve months to March 2021).
Therefore, Iridium Communications has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Telecom industry average of 11%.
In the above chart we have measured Iridium Communications' 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 Iridium Communications here for free.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at Iridium Communications. To be more specific, the ROCE was 5.5% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Iridium Communications to turn into a multi-bagger.
Our Take On Iridium Communications' ROCE
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. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 317%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing to note, we've identified 1 warning sign with Iridium Communications and understanding this should be part of your investment process.
While Iridium Communications 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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