Avation's (LON:AVAP) Returns On Capital Not Reflecting Well On The Business
To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. 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 Avation (LON:AVAP), we weren't too upbeat about how things were going.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Avation is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = US$34m ÷ (US$1.2b - US$141m) (Based on the trailing twelve months to June 2023).
So, Avation has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 15%.
See our latest analysis for Avation
Above you can see how the current ROCE for Avation 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 The Trend Of ROCE Can Tell Us
In terms of Avation's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 6.0% five years 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Avation to turn into a multi-bagger.
In Conclusion...
In summary, it's unfortunate that Avation is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 56% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing Avation we've found 3 warning signs (2 are significant!) that you should be aware of before investing here.
While Avation 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.
