Capital Allocation Trends At Gattaca (LON:GATC) Aren't Ideal
To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. Having said that, after a brief look, Gattaca (LON:GATC) we aren't filled with optimism, but let's investigate further.
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. To calculate this metric for Gattaca, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0026 = UK£86k ÷ (UK£81m - UK£48m) (Based on the trailing twelve months to July 2022).
Thus, Gattaca has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 15%.
See our latest analysis for Gattaca
In the above chart we have measured Gattaca's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Gattaca here for free.
What The Trend Of ROCE Can Tell Us
The trend of ROCE at Gattaca is showing some signs of weakness. To be more specific, today's ROCE was 13% five years ago but has since fallen to 0.3%. On top of that, the business is utilizing 70% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 59%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
What We Can Learn From Gattaca's ROCE
To see Gattaca reducing the capital employed in the business in tandem with diminishing returns, is concerning. It should come as no surprise then that the stock has fallen 60% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Like most companies, Gattaca does come with some risks, and we've found 1 warning sign that you should be aware of.
While Gattaca may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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