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Incitec Pivot (ASX:IPL) Could Be Struggling To Allocate Capital

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Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. And from a first read, things don't look too good at Incitec Pivot (ASX:IPL), so let's see why.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Incitec Pivot is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.034 = AU$260m ÷ (AU$8.8b - AU$1.2b) (Based on the trailing twelve months to March 2021).

Therefore, Incitec Pivot has an ROCE of 3.4%. In absolute terms, that's a low return but it's around the Chemicals industry average of 4.2%.

Check out our latest analysis for Incitec Pivot

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Above you can see how the current ROCE for Incitec Pivot compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Incitec Pivot.

What Does the ROCE Trend For Incitec Pivot Tell Us?

In terms of Incitec Pivot's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 6.8% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Incitec Pivot to turn into a multi-bagger.

What We Can Learn From Incitec Pivot's ROCE

In summary, it's unfortunate that Incitec Pivot is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 10% 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.

Incitec Pivot does have some risks though, and we've spotted 2 warning signs for Incitec Pivot that you might be interested in.

While Incitec Pivot 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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