African Media Entertainment's (JSE:AME) Returns On Capital Tell Us There Is Reason To Feel Uneasy

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at African Media Entertainment (JSE:AME), 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 African Media Entertainment:

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

0.16 = R42m ÷ (R313m - R50m) (Based on the trailing twelve months to September 2022).

Thus, African Media Entertainment has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 9.3% generated by the Media industry.

Check out our latest analysis for African Media Entertainment

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

What The Trend Of ROCE Can Tell Us

In terms of African Media Entertainment's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 26% that they were earning five years ago. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on African Media Entertainment becoming one if things continue as they have.

The Key Takeaway

In summary, it's unfortunate that African Media Entertainment is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about African Media Entertainment, we've spotted 4 warning signs, and 1 of them makes us a bit uncomfortable.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.