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Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Yellow Pages (TSE:Y) we aren't filled with optimism, but let's investigate further.
What Is 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 Yellow Pages is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.41 = CA$48m ÷ (CA$162m - CA$42m) (Based on the trailing twelve months to June 2024).
So, Yellow Pages has an ROCE of 41%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 6.7%.
See our latest analysis for Yellow Pages
In the above chart we have measured Yellow Pages' 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 Yellow Pages for free.
The Trend Of ROCE
The trend of ROCE at Yellow Pages is showing some signs of weakness. To be more specific, today's ROCE was 54% five years ago but has since fallen to 41%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 44% over that same period. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, Yellow Pages has done well to pay down its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
In summary, it's unfortunate that Yellow Pages is shrinking its capital base and also generating lower returns. Yet despite these concerning fundamentals, the stock has performed strongly with a 43% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.