When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Enerpac Tool Group (NYSE:EPAC), we've spotted some signs that it could be struggling, so let's investigate.
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 Enerpac Tool Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = US$20m ÷ (US$809m - US$115m) (Based on the trailing twelve months to February 2021).
Therefore, Enerpac Tool Group has an ROCE of 2.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.9%.
In the above chart we have measured Enerpac Tool Group's 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 Enerpac Tool Group.
The Trend Of ROCE
The trend of ROCE at Enerpac Tool Group is showing some signs of weakness. Unfortunately, returns have declined substantially over the last five years to the 2.8% we see today. In addition to that, Enerpac Tool Group is now employing 42% less capital than it was five years ago. 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
The Bottom Line
To see Enerpac Tool Group reducing the capital employed in the business in tandem with diminishing returns, is concerning. Despite the concerning underlying trends, the stock has actually gained 7.3% 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.
If you'd like to know more about Enerpac Tool Group, we've spotted 4 warning signs, and 1 of them is a bit concerning.
While Enerpac Tool Group 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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