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If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base 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. Having said that, after a brief look, M&C Saatchi (LON:SAA) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for M&C Saatchi:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = UK£12m ÷ (UK£296m - UK£196m) (Based on the trailing twelve months to June 2021).
Therefore, M&C Saatchi has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Media industry average of 11%.
In the above chart we have measured M&C Saatchi's 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 Can We Tell From M&C Saatchi's ROCE Trend?
We are a bit worried about the trend of returns on capital at M&C Saatchi. About five years ago, returns on capital were 16%, 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on M&C Saatchi becoming one if things continue as they have.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 66%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Key Takeaway
In summary, it's unfortunate that M&C Saatchi is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 44% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for M&C Saatchi (of which 1 is a bit concerning!) that you should know about.
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.