When researching a stock for investment, what can tell us that the company is 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Universal Stainless & Alloy Products (NASDAQ:USAP), we weren't too upbeat about how things were going.
What Is 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 Universal Stainless & Alloy Products, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0024 = US$760k ÷ (US$348m - US$36m) (Based on the trailing twelve months to June 2022).
Thus, Universal Stainless & Alloy Products has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 21%.
In the above chart we have measured Universal Stainless & Alloy Products' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about Universal Stainless & Alloy Products, given the returns are trending downwards. About five years ago, returns on capital were 0.4%, 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. 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. If these trends continue, we wouldn't expect Universal Stainless & Alloy Products to turn into a multi-bagger.
What We Can Learn From Universal Stainless & Alloy Products' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 64% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 2 warning signs with Universal Stainless & Alloy Products and understanding them should be part of your investment process.
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.
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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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