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If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at Castings (LON:CGS), we've spotted some signs that it could be struggling, so let's investigate.
Understanding 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. To calculate this metric for Castings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.037 = UK£4.9m ÷ (UK£158m - UK£25m) (Based on the trailing twelve months to March 2021).
So, Castings has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 18%.
See our latest analysis for Castings
In the above chart we have measured Castings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Castings' ROCE Trending?
In terms of Castings' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Castings becoming one if things continue as they have.
The Bottom Line
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors must expect better things on the horizon though because the stock has risen 4.2% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Castings (including 1 which is concerning) .