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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 reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at Sensient Technologies (NYSE:SXT), so let's see why.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Sensient Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$152m ÷ (US$1.7b - US$201m) (Based on the trailing twelve months to March 2020).
Therefore, Sensient Technologies has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 9.9%.
In the above chart we have a measured Sensient Technologies' 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 Sensient Technologies here for free.
What Does the ROCE Trend For Sensient Technologies Tell Us?
In terms of Sensient Technologies' historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 15%, 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 Sensient Technologies to turn into a multi-bagger.
In summary, it's unfortunate that Sensient Technologies is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 8.4% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One more thing to note, we've identified 5 warning signs with Sensient Technologies and understanding these 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.
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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