Adcorp Holdings (JSE:ADR) Has Some Difficulty Using Its Capital Effectively

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 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 Adcorp Holdings (JSE:ADR), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Adcorp Holdings:

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

0.063 = R112m ÷ (R3.1b - R1.3b) (Based on the trailing twelve months to August 2024).

So, Adcorp Holdings has an ROCE of 6.3%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 14%.

View our latest analysis for Adcorp Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Adcorp Holdings' ROCE against it's prior returns. If you're interested in investigating Adcorp Holdings' past further, check out this free graph covering Adcorp Holdings' past earnings, revenue and cash flow.

So How Is Adcorp Holdings' ROCE Trending?

The trend of ROCE at Adcorp Holdings is showing some signs of weakness. The company used to generate 9.7% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 34% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a separate but related note, it's important to know that Adcorp Holdings has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Adcorp Holdings' ROCE

To see Adcorp Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to continue researching Adcorp Holdings, you might be interested to know about the 4 warning signs that our analysis has discovered.

While Adcorp Holdings 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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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.