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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? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing 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 we looked into KAP (ETR:IUR), the trends above didn't look too great.
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. To calculate this metric for KAP, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.016 = €3.1m ÷ (€317m - €130m) (Based on the trailing twelve months to December 2023).
So, KAP has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Industrials industry average of 6.8%.
Check out our latest analysis for KAP
Historical performance is a great place to start when researching a stock so above you can see the gauge for KAP's ROCE against it's prior returns. If you're interested in investigating KAP's past further, check out this free graph covering KAP's past earnings, revenue and cash flow.
How Are Returns Trending?
We are a bit anxious about the trends of ROCE at KAP. Unfortunately, returns have declined substantially over the last five years to the 1.6% we see today. In addition to that, KAP is now employing 34% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 41%, 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.
Our Take On KAP's ROCE
To see KAP reducing the capital employed in the business in tandem with diminishing returns, is concerning. Long term shareholders who've owned the stock over the last five years have experienced a 63% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.