What financial metrics can indicate to us that a company is maturing or even in decline? 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. 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 NZ Automotive Investments (NZSE:NZA), we weren’t too upbeat about how things were going.
Understanding 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 NZ Automotive Investments is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = NZ$2.6m ÷ (NZ$36m – NZ$16m) (Based on the trailing twelve months to September 2022).
Thus, NZ Automotive Investments has an ROCE of 12%. That’s a pretty standard return and it’s in line with the industry average of 12%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of NZ Automotive Investments, check out these free graphs here.
What Does the ROCE Trend For NZ Automotive Investments Tell Us?
In terms of NZ Automotive Investments’ historical ROCE movements, the trend doesn’t inspire confidence. To be more specific, the ROCE was 24% one year ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn’t expect NZ Automotive Investments to turn into a multi-bagger.
Another thing to note, NZ Automotive Investments has a high ratio of current liabilities to total assets of 43%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we’d like to see this reduce as that would mean fewer obligations bearing risks.
In the end, the trend of lower returns on the same amount of capital isn’t typically an indication that we’re looking at a growth stock. Long term shareholders who’ve owned the stock over the last year have experienced a 63% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
On a final note, we found 4 warning signs for NZ Automotive Investments (1 can’t be ignored) you should be aware of.
While NZ Automotive Investments isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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