These Return Metrics Don't Make Elementis (LON:ELM) Look Too Strong
When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Elementis (LON:ELM), the trends above didn't look too great.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Elementis:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.076 = US$103m ÷ (US$1.5b - US$137m) (Based on the trailing twelve months to June 2023).
So, Elementis has an ROCE of 7.6%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 12%.
View our latest analysis for Elementis
In the above chart we have measured Elementis' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Elementis.
What Can We Tell From Elementis' ROCE Trend?
There is reason to be cautious about Elementis, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 10% 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. 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 Elementis to turn into a multi-bagger.
What We Can Learn From Elementis' ROCE
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. Investors haven't taken kindly to these developments, since the stock has declined 50% 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.
Elementis could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
While Elementis isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
