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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. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Ensign Energy Services (TSE:ESI), we've spotted some signs that it could be struggling, so let's investigate.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Ensign Energy Services is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0024 = CA$8.1m ÷ (CA$3.6b - CA$285m) (Based on the trailing twelve months to March 2020).
Thus, Ensign Energy Services has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 14%.
In the above chart we have a measured Ensign Energy Services' 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 Ensign Energy Services here for free.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at Ensign Energy Services. To be more specific, the ROCE was 6.1% five years ago, but since then it has dropped noticeably. 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 Ensign Energy Services to turn into a multi-bagger.
Our Take On Ensign Energy Services' ROCE
In summary, it's unfortunate that Ensign Energy Services is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 87% during the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Ensign Energy Services does come with some risks though, we found 5 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...
While Ensign Energy Services may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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