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What underlying fundamental trends can indicate that a company might be in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Orion Engineered Carbons (NYSE:OEC), the trends above didn't look too great.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Orion Engineered Carbons, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = US$84m ÷ (US$1.3b - US$328m) (Based on the trailing twelve months to September 2020).
So, Orion Engineered Carbons has an ROCE of 8.3%. Even though it's in line with the industry average of 8.1%, it's still a low return by itself.
In the above chart we have measured Orion Engineered Carbons' 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 Does the ROCE Trend For Orion Engineered Carbons Tell Us?
In terms of Orion Engineered Carbons' 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. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Orion Engineered Carbons becoming one if things continue as they have.
The Bottom Line
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. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 97% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you want to continue researching Orion Engineered Carbons, you might be interested to know about the 4 warning signs that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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