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To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Carclo (LON:CAR), we weren't too upbeat about how things were going.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Carclo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = UK£4.9m ÷ (UK£101m - UK£29m) (Based on the trailing twelve months to March 2024).
Therefore, Carclo has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.7%.
View our latest analysis for Carclo
In the above chart we have measured Carclo's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Carclo for free.
What Does the ROCE Trend For Carclo Tell Us?
There is reason to be cautious about Carclo, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 9.4% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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. If these trends continue, we wouldn't expect Carclo to turn into a multi-bagger.
On a related note, Carclo has decreased its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. 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 Carclo's ROCE
In summary, it's unfortunate that Carclo is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 23% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.