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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. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into ADT (NYSE:ADT), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for ADT:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0025 = US$36m ÷ (US$16b - US$1.4b) (Based on the trailing twelve months to September 2021).
So, ADT has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 8.6%.
Above you can see how the current ROCE for ADT compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering ADT here for free.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at ADT. To be more specific, the ROCE was 1.0% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. If these trends continue, we wouldn't expect ADT to turn into a multi-bagger.
Our Take On ADT's ROCE
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. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 26% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing to note, we've identified 3 warning signs with ADT and understanding them should be part of your investment process.
While ADT 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.