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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? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Knowles (NYSE:KN), we weren't too hopeful.
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. To calculate this metric for Knowles, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.037 = US$50m ÷ (US$1.7b - US$297m) (Based on the trailing twelve months to December 2020).
Therefore, Knowles has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 11%.
In the above chart we have measured Knowles' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Knowles here for free.
What The Trend Of ROCE Can Tell Us
In terms of Knowles' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 4.9% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Knowles becoming one if things continue as they have.
The Bottom Line On Knowles' ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 55% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to continue researching Knowles, you might be interested to know about the 3 warning signs that our analysis has discovered.
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.
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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