Famous Brands (JSE:FBR) Could Be At Risk Of Shrinking As A Company

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining 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. And from a first read, things don't look too good at Famous Brands (JSE:FBR), so let's see why.

Understanding Return On Capital Employed (ROCE)

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 Famous Brands:

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

0.29 = R626m ÷ (R3.0b - R835m) (Based on the trailing twelve months to August 2021).

Therefore, Famous Brands has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Hospitality industry average of 7.2%.

View our latest analysis for Famous Brands

Historical performance is a great place to start when researching a stock so above you can see the gauge for Famous Brands' ROCE against it's prior returns. If you'd like to look at how Famous Brands has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Famous Brands' ROCE Trend?

There is reason to be cautious about Famous Brands, given the returns are trending downwards. To be more specific, the ROCE was 43% 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 Famous Brands to turn into a multi-bagger.

On a related note, Famous Brands has decreased its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, it's unfortunate that Famous Brands is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 54% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to know some of the risks facing Famous Brands we've found 3 warning signs (2 are a bit concerning!) that you should be aware of before investing here.

Famous Brands is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.