Victrex (LON:VCT) Could Be Struggling To Allocate Capital
What underlying fundamental trends can indicate that a company might be in decline? 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Victrex (LON:VCT), we weren't too upbeat about how things were going.
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. To calculate this metric for Victrex, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = UK£99m ÷ (UK£642m - UK£85m) (Based on the trailing twelve months to September 2022).
Thus, Victrex has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 10% it's much better.
Check out our latest analysis for Victrex
In the above chart we have measured Victrex's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Victrex.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Victrex. Unfortunately the returns on capital have diminished from the 23% 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. 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 Victrex to turn into a multi-bagger.
The Key Takeaway
In summary, it's unfortunate that Victrex is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 18% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
On a separate note, we've found 1 warning sign for Victrex you'll probably want to know about.
While Victrex 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.
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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.
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