When researching a stock for investment, what can tell us that the company is in decline? 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. On that note, looking into Profire Energy (NASDAQ:PFIE), we weren't too upbeat about how things were going.
What Is 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 Profire Energy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0038 = US$167k ÷ (US$49m - US$5.3m) (Based on the trailing twelve months to June 2022).
So, Profire Energy has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 5.8%.
Check out our latest analysis for Profire Energy
In the above chart we have measured Profire Energy's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Profire Energy here for free.
What Does the ROCE Trend For Profire Energy Tell Us?
We are a bit worried about the trend of returns on capital at Profire Energy. About five years ago, returns on capital were 8.4%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Profire Energy 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 32% 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.
One more thing to note, we've identified 2 warning signs with Profire Energy and understanding these should be part of your investment process.
While Profire Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.