Does Pason Systems' (TSE:PSI) Returns On Capital Reflect Well On The Business?
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. On that note, looking into Pason Systems (TSE:PSI), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Pason Systems, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CA$48m ÷ (CA$407m - CA$39m) (Based on the trailing twelve months to June 2020).
Therefore, Pason Systems has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Energy Services industry average of 11%.
View our latest analysis for Pason Systems
In the above chart we have measured Pason Systems' 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 Pason Systems.
What The Trend Of ROCE Can Tell Us
In terms of Pason Systems' historical ROCE trend, it isn't fantastic. The company used to generate 24% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 30% 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.
The Bottom Line
In summary, it's unfortunate that Pason Systems is shrinking its capital base and also generating lower returns. It should come as no surprise then that the stock has fallen 66% 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.
Pason Systems does have some risks, we noticed 4 warning signs (and 2 which are significant) we think you should know about.
While Pason Systems 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.
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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