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If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? 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. 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 Pharos Energy (LON:PHAR), 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. The formula for this calculation on Pharos Energy is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0054 = US$2.2m ÷ (US$441m - US$35m) (Based on the trailing twelve months to June 2024).
Therefore, Pharos Energy has an ROCE of 0.5%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 8.3%.
See our latest analysis for Pharos Energy
In the above chart we have measured Pharos Energy's 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 analyst report for Pharos Energy .
So How Is Pharos Energy's ROCE Trending?
In terms of Pharos Energy's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 8.8% five years ago but has since fallen to 0.5%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 49% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
The Bottom Line
To see Pharos Energy 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 57% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.