Be Wary Of African Media Entertainment (JSE:AME) And Its Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, African Media Entertainment (JSE:AME) we aren't filled with optimism, but let's investigate further.

What is 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 African Media Entertainment:

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

0.085 = R22m ÷ (R303m - R43m) (Based on the trailing twelve months to March 2021).

Therefore, African Media Entertainment has an ROCE of 8.5%. Even though it's in line with the industry average of 8.8%, it's still a low return by itself.

See our latest analysis for African Media Entertainment

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at African Media Entertainment. Unfortunately the returns on capital have diminished from the 31% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 African Media Entertainment to turn into a multi-bagger.

On a side note, African Media Entertainment has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On African Media Entertainment's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 43% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 5 warning signs for African Media Entertainment (1 makes us a bit uncomfortable) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.

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