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What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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. In light of that, from a first glance at Avation (LON:AVAP), we've spotted some signs that it could be struggling, so let's investigate.
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. The formula for this calculation on Avation is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = US$49m ÷ (US$1.2b - US$118m) (Based on the trailing twelve months to December 2022).
Therefore, Avation has an ROCE of 4.6%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 15%.
View our latest analysis for Avation
Above you can see how the current ROCE for Avation compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Avation.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Avation, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 6.1% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Avation becoming one if things continue as they have.
The Bottom Line
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 53% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.