What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don’t look too good at NZ Automotive Investments (NZSE:NZA), so let’s see why.
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. The formula for this calculation on NZ Automotive Investments is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.17 = NZ$3.5m ÷ (NZ$38m – NZ$17m) (Based on the trailing twelve months to March 2022).
Thus, NZ Automotive Investments has an ROCE of 17%. By itself that’s a normal return on capital and it’s in line with the industry’s average returns of 17%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for NZ Automotive Investments’ ROCE against it’s prior returns. If you’d like to look at how NZ Automotive Investments has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For NZ Automotive Investments Tell Us?
There is reason to be cautious about NZ Automotive Investments, given the returns are trending downwards. To be more specific, the ROCE was 26% one year ago, but since then it has dropped noticeably. 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 one year. If these trends continue, we wouldn’t expect NZ Automotive Investments to turn into a multi-bagger.
On a separate but related note, it’s important to know that NZ Automotive Investments has a current liabilities to total assets ratio of 44%, which we’d consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
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 56% from where it was year ago. That being the case, unless the underlying trends revert to a more positive trajectory, we’d consider looking elsewhere.
One more thing: We’ve identified 5 warning signs with NZ Automotive Investments (at least 4 which make us uncomfortable) , and understanding these would certainly be useful.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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