When researching a stock for investment, what can tell us that the company is in decline? 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Energy World (ASX:EWC), so let's see why.
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. Analysts use this formula to calculate it for Energy World:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0042 = US$6.6m ÷ (US$1.6b - US$44m) (Based on the trailing twelve months to December 2023).
Thus, Energy World has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Renewable Energy industry average of 1.8%.
Check out our latest analysis for Energy World
Historical performance is a great place to start when researching a stock so above you can see the gauge for Energy World's ROCE against it's prior returns. If you're interested in investigating Energy World's past further, check out this free graph covering Energy World's past earnings, revenue and cash flow.
The Trend Of ROCE
There is reason to be cautious about Energy World, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 2.5% 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 Energy World to turn into a multi-bagger.
On a side note, Energy World has done well to pay down its current liabilities to 2.8% of total assets. So we could link some of this to the decrease in ROCE. 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.