Want to participate in a short research study? Help shape the future of investing tools and earn a $40 gift card!
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 indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Avaya Holdings (NYSE:AVYA), we weren't too hopeful.
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. Analysts use this formula to calculate it for Avaya Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.036 = US$182m ÷ (US$6.2b - US$1.2b) (Based on the trailing twelve months to March 2020).
Thus, Avaya Holdings has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Software industry average of 9.3%.
In the above chart we have a measured Avaya Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Avaya Holdings.
So How Is Avaya Holdings' ROCE Trending?
There is reason to be cautious about Avaya Holdings, given the returns are trending downwards. About five years ago, returns on capital were 7.9%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Avaya Holdings to turn into a multi-bagger.
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors must expect better things on the horizon though because the stock has risen 5.1% in the last year. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Avaya Holdings does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
While Avaya Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.