Argan (NYSE:AGX) Has Some Difficulty Using Its Capital Effectively
What underlying fundamental trends can indicate that a company might be 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. 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. On that note, looking into Argan (NYSE:AGX), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What Is It?
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 Argan is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$39m ÷ (US$411m - US$135m) (Based on the trailing twelve months to October 2022).
Thus, Argan has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.9% generated by the Construction industry.
Check out our latest analysis for Argan
Above you can see how the current ROCE for Argan compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Argan Tell Us?
The trend of returns that Argan is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 14% we see today. On top of that, the business is utilizing 21% less capital within its operations. The fact that both are shrinking is an indication that the business is going through some tough times. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, Argan has done well to pay down its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. 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
To see Argan reducing the capital employed in the business in tandem with diminishing returns, is concerning. Investors must expect better things on the horizon though because the stock has risen 22% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you'd like to know about the risks facing Argan, we've discovered 2 warning signs that you should be aware of.
While Argan 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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