Valhi's (NYSE:VHI) Returns On Capital Tell Us There Is Reason To Feel Uneasy
To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. On that note, looking into Valhi (NYSE:VHI), we weren't too upbeat about how things were going.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Valhi is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.003 = US$6.8m ÷ (US$2.7b - US$394m) (Based on the trailing twelve months to June 2023).
Thus, Valhi has an ROCE of 0.3%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 11%.
See our latest analysis for Valhi
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 Valhi 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 Valhi's ROCE Trend?
There is reason to be cautious about Valhi, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 16% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Valhi becoming one if things continue as they have.
What We Can Learn From Valhi's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Unsurprisingly then, the stock has dived 74% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we found 4 warning signs for Valhi (2 are concerning) 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.
