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When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at CF Industries Holdings (NYSE:CF), so let's see why.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for CF Industries Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = US$928m ÷ (US$12b - US$1.2b) (Based on the trailing twelve months to March 2020).
Therefore, CF Industries Holdings has an ROCE of 8.3%. On its own, that's a low figure but it's around the 9.1% average generated by the Chemicals industry.
In the above chart we have a measured CF Industries Holdings' 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 CF Industries Holdings here for free.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at CF Industries Holdings. To be more specific, the ROCE was 15% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 CF Industries Holdings to turn into a multi-bagger.
In summary, it's unfortunate that CF Industries Holdings is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 37% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Like most companies, CF Industries Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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