When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within L.S. Starrett (NYSE:SCX), we weren't too hopeful.
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. The formula for this calculation on L.S. Starrett is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.047 = US$7.2m ÷ (US$179m - US$25m) (Based on the trailing twelve months to March 2020).
Thus, L.S. Starrett has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.1%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how L.S. Starrett has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From L.S. Starrett's ROCE Trend?
We are a bit worried about the trend of returns on capital at L.S. Starrett. To be more specific, the ROCE was 7.4% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on L.S. Starrett becoming one if things continue as they have.
In summary, it's unfortunate that L.S. Starrett is generating lower returns from the same amount of capital. We expect this has contributed to the stock plummeting 74% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know about the risks facing L.S. Starrett, we've discovered 1 warning sign that you should be aware of.
While L.S. Starrett 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email email@example.com.