Yahoo Finance Embelton (ASX:EMB) Has Some Difficulty Using Its Capital Effectively
When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Embelton (ASX:EMB), so let's see why.
What Is 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. The formula for this calculation on Embelton is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = AU$1.4m ÷ (AU$37m - AU$17m) (Based on the trailing twelve months to June 2023).
Therefore, Embelton has an ROCE of 6.7%. In absolute terms, that's a low return and it also under-performs the Building industry average of 11%.
Check out our latest analysis for Embelton
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're interested in investigating Embelton's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
There is reason to be cautious about Embelton, given the returns are trending downwards. About five years ago, returns on capital were 18%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Embelton becoming one if things continue as they have.
On a side note, Embelton's current liabilities have increased over the last five years to 46% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
The Bottom Line On Embelton's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. And long term shareholders have watched their investments stay flat over the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing Embelton we've found 5 warning signs (2 don't sit too well with us!) that you should be aware of before investing here.
While Embelton 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.
