When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into Bodycote (LON:BOY), we weren't too upbeat about how things were going.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Bodycote is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = UK£87m ÷ (UK£1.1b - UK£282m) (Based on the trailing twelve months to June 2022).
So, Bodycote has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Machinery industry average of 11%.
In the above chart we have measured Bodycote's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Bodycote.
What Can We Tell From Bodycote's ROCE Trend?
We are a bit worried about the trend of returns on capital at Bodycote. About five years ago, returns on capital were 14%, 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Bodycote to turn into a multi-bagger.
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 27% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know about the risks facing Bodycote, we've discovered 1 warning sign that you should be aware of.
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.
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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.
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