When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Signet Jewelers (NYSE:SIG), we weren't too hopeful.
What is 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. Analysts use this formula to calculate it for Signet Jewelers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.036 = US$151m ÷ (US$6.2b - US$2.0b) (Based on the trailing twelve months to January 2021).
Thus, Signet Jewelers has an ROCE of 3.6%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 15%.
Above you can see how the current ROCE for Signet Jewelers compares to its prior returns on capital, but there's only so much you can tell from the past. 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 Signet Jewelers Tell Us?
The trend of returns that Signet Jewelers is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 3.6% we see today. In addition to that, Signet Jewelers is now employing 21% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
What We Can Learn From Signet Jewelers' ROCE
In summary, it's unfortunate that Signet Jewelers is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Signet Jewelers does have some risks though, and we've spotted 1 warning sign for Signet Jewelers that you might be interested in.
While Signet Jewelers 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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