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What financial metrics can indicate to us that a company is maturing or even 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Ethan Allen Interiors (NYSE:ETH) 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. The formula for this calculation on Ethan Allen Interiors is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = US$31m ÷ (US$636m - US$187m) (Based on the trailing twelve months to December 2020).
Thus, Ethan Allen Interiors has an ROCE of 7.0%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 14%.
Above you can see how the current ROCE for Ethan Allen Interiors compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Ethan Allen Interiors here for free.
What Does the ROCE Trend For Ethan Allen Interiors Tell Us?
There is reason to be cautious about Ethan Allen Interiors, given the returns are trending downwards. About five years ago, returns on capital were 16%, 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Ethan Allen Interiors to turn into a multi-bagger.
The Bottom Line
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 10% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Ethan Allen Interiors does have some risks though, and we've spotted 5 warning signs for Ethan Allen Interiors that you might be interested in.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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