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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? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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 glancing at the trends within Gentherm (NASDAQ:THRM), we weren't too hopeful.
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. The formula for this calculation on Gentherm is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$114m ÷ (US$932m - US$223m) (Based on the trailing twelve months to March 2021).
Thus, Gentherm has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 11% generated by the Auto Components industry.
In the above chart we have measured Gentherm's 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 Gentherm.
So How Is Gentherm's ROCE Trending?
In terms of Gentherm's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 21% 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. 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 Gentherm becoming one if things continue as they have.
The Bottom Line On Gentherm's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 93% 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'd like to know about the risks facing Gentherm, we've discovered 1 warning sign that you should be aware of.
While Gentherm isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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