What underlying fundamental trends can indicate that a company might be in decline? 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. 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 African Media Entertainment (JSE:AME), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for African Media Entertainment, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = R42m ÷ (R313m - R50m) (Based on the trailing twelve months to September 2022).
Therefore, African Media Entertainment has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Media industry average of 9.3% it's much better.
Check out our latest analysis for African Media Entertainment
Historical performance is a great place to start when researching a stock so above you can see the gauge for African Media Entertainment's ROCE against it's prior returns. If you'd like to look at how African Media Entertainment has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about African Media Entertainment, given the returns are trending downwards. To be more specific, the ROCE was 26% five years ago, but since then it has dropped noticeably. 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 African Media Entertainment becoming one if things continue as they have.
The Key Takeaway
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 16% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.