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Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within ForFarmers (AMS:FFARM), we weren't too hopeful.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ForFarmers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = €31m ÷ (€1.0b - €482m) (Based on the trailing twelve months to June 2022).
Therefore, ForFarmers has an ROCE of 5.9%. In absolute terms, that's a low return and it also under-performs the Food industry average of 8.8%.
View our latest analysis for ForFarmers
In the above chart we have measured ForFarmers' 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 ForFarmers.
What Can We Tell From ForFarmers' ROCE Trend?
We are a bit worried about the trend of returns on capital at ForFarmers. Unfortunately the returns on capital have diminished from the 14% 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on ForFarmers becoming one if things continue as they have.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 48%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Bottom Line On ForFarmers' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 65% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.