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When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Sylogist (TSE:SYZ) we aren't filled with optimism, but let's investigate further.
What Is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Sylogist, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = CA$4.1m ÷ (CA$99m - CA$55m) (Based on the trailing twelve months to September 2024).
Thus, Sylogist has an ROCE of 9.4%. In absolute terms, that's a low return and it also under-performs the Software industry average of 15%.
See our latest analysis for Sylogist
In the above chart we have measured Sylogist'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 Sylogist .
How Are Returns Trending?
The trend of returns that Sylogist is generating are raising some concerns. To be more specific, today's ROCE was 22% five years ago but has since fallen to 9.4%. In addition to that, Sylogist is now employing 27% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. 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.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 55%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 9.4%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
In Conclusion...
In summary, it's unfortunate that Sylogist is shrinking its capital base and also generating lower returns. Despite the concerning underlying trends, the stock has actually gained 26% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.