If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Midway (ASX:MWY), the trends above didn't look too great.
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 Midway, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.036 = AU$8.3m ÷ (AU$283m - AU$52m) (Based on the trailing twelve months to December 2019).
So, Midway has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Forestry industry average of 7.3%.
Check out our latest analysis for Midway
In the above chart we have a measured Midway's 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 Midway's ROCE Trending?
In terms of Midway's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 4.7% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Midway to turn into a multi-bagger.
The Bottom Line On Midway's 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 63% over the last three years, so it looks like investors are recognizing these changes. Unless these trends revert to a more positive trajectory, we would look elsewhere.
If you'd like to know about the risks facing Midway, we've discovered 4 warning signs that you should be aware of.
While Midway isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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