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When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Card Factory (LON:CARD) we aren't filled with optimism, but let's investigate further.
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 Card Factory is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = UK£73m ÷ (UK£577m - UK£140m) (Based on the trailing twelve months to July 2023).
Thus, Card Factory has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 13% it's much better.
See our latest analysis for Card Factory
Above you can see how the current ROCE for Card Factory compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at Card Factory. About five years ago, returns on capital were 23%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Card Factory to turn into a multi-bagger.
On a side note, Card Factory's current liabilities have increased over the last five years to 24% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 17%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
In Conclusion...
In summary, it's unfortunate that Card Factory is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 38% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.