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To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Franklin Covey (NYSE:FC), so let's see why.
Understanding Return On Capital Employed (ROCE)
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 Franklin Covey, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = US$9.9m ÷ (US$213m - US$105m) (Based on the trailing twelve months to May 2021).
So, Franklin Covey has an ROCE of 9.2%. In absolute terms, that's a low return but it's around the Professional Services industry average of 11%.
In the above chart we have measured Franklin Covey's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
In terms of Franklin Covey's historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 12% five years ago but has since fallen to 9.2%. In addition to that, Franklin Covey is now employing 21% less capital than it was five years ago. 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 49%, 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.
Our Take On Franklin Covey's ROCE
To see Franklin Covey reducing the capital employed in the business in tandem with diminishing returns, is concerning. Since the stock has skyrocketed 128% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know more about Franklin Covey, we've spotted 3 warning signs, and 1 of them is a bit concerning.
While Franklin Covey isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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