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When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Falcon Minerals (NASDAQ:FLMN), the trends above didn't look too great.
What is 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 Falcon Minerals, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = US$11m ÷ (US$279m - US$3.0m) (Based on the trailing twelve months to September 2020).
So, Falcon Minerals has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 9.4%.
In the above chart we have measured Falcon Minerals' 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 Falcon Minerals.
What Does the ROCE Trend For Falcon Minerals Tell Us?
We are a bit anxious about the trends of ROCE at Falcon Minerals. To be more specific, today's ROCE was 10% three years ago but has since fallen to 4.2%. What's equally concerning is that the amount of capital deployed in the business has shrunk by 25% over that same period. 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.
The Bottom Line On Falcon Minerals' ROCE
In summary, it's unfortunate that Falcon Minerals is shrinking its capital base and also generating lower returns. And long term shareholders have watched their investments stay flat over the last year. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Falcon Minerals (including 1 which shouldn't be ignored) .
While Falcon Minerals 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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