When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after we looked into Adacel Technologies (ASX:ADA), the trends above didn't look too great.
What is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Adacel Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = US$3.9m ÷ (US$28m - US$9.6m) (Based on the trailing twelve months to December 2021).
Therefore, Adacel Technologies has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Software industry average of 11%.
Above you can see how the current ROCE for Adacel Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Adacel Technologies' ROCE Trending?
In terms of Adacel Technologies' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 40%, however they're now substantially lower than that as we saw above. 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 Adacel Technologies to turn into a multi-bagger.
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. Long term shareholders who've owned the stock over the last five years have experienced a 56% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Adacel Technologies does have some risks, we noticed 5 warning signs (and 1 which is a bit concerning) we think you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.