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What underlying fundamental trends can indicate that a company might be in decline? 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at Card Factory (LON:CARD), so let's see why.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Card Factory, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = UK£29m ÷ (UK£589m - UK£105m) (Based on the trailing twelve months to July 2020).
So, Card Factory has an ROCE of 6.1%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 10%.
Above you can see how the current ROCE for Card Factory 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 Card Factory here for free.
What Does the ROCE Trend For Card Factory Tell Us?
We are a bit worried about the trend of returns on capital at Card Factory. Unfortunately the returns on capital have diminished from the 20% that they were earning five years ago. 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 Card Factory to turn into a multi-bagger.
The Bottom Line On Card Factory's ROCE
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. We expect this has contributed to the stock plummeting 88% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a separate note, we've found 3 warning signs for Card Factory you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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