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When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, A2B Australia (ASX:A2B) we aren't filled with optimism, but let's investigate further.
What is Return On Capital Employed (ROCE)?
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 A2B Australia is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = AU$15m ÷ (AU$235m - AU$54m) (Based on the trailing twelve months to December 2019).
Thus, A2B Australia has an ROCE of 8.2%. On its own, that's a low figure but it's around the 6.9% average generated by the Transportation industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for A2B Australia's ROCE against it's prior returns. If you're interested in investigating A2B Australia's past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
The trend of returns that A2B Australia is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 8.2% we see today. In addition to that, A2B Australia is now employing 65% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, A2B Australia's current liabilities have increased over the last five years to 23% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Key Takeaway
To see A2B Australia 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 64% 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.
On a final note, we found 4 warning signs for A2B Australia (1 shouldn't be ignored) you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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.
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