If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Goodwin (LON:GDWN), we weren't too hopeful.
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. To calculate this metric for Goodwin, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = UK£12m ÷ (UK£192m - UK£63m) (Based on the trailing twelve months to April 2020).
Therefore, Goodwin has an ROCE of 9.4%. In absolute terms, that's a low return but it's around the Machinery industry average of 12%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Goodwin's ROCE against it's prior returns. If you'd like to look at how Goodwin has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is Goodwin's ROCE Trending?
There is reason to be cautious about Goodwin, given the returns are trending downwards. To be more specific, the ROCE was 19% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Goodwin becoming one if things continue as they have.
The Key Takeaway
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. However the stock has delivered a 69% return to shareholders over the last five years, so investors might be expecting the trends to turn around. 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 want to know some of the risks facing Goodwin we've found 4 warning signs (1 is potentially serious!) that you should be aware of before investing here.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.