Be Wary Of Compumedics (ASX:CMP) And Its Returns On Capital
When researching a stock for investment, what can tell us that the company is 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Compumedics (ASX:CMP), we've spotted some signs that it could be struggling, so let's investigate.
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. To calculate this metric for Compumedics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = AU$2.3m ÷ (AU$41m - AU$21m) (Based on the trailing twelve months to December 2023).
Therefore, Compumedics has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 7.9% generated by the Medical Equipment industry.
Check out our latest analysis for Compumedics
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're interested in investigating Compumedics' past further, check out this free graph covering Compumedics' past earnings, revenue and cash flow.
What Does the ROCE Trend For Compumedics Tell Us?
The trend of ROCE at Compumedics is showing some signs of weakness. To be more specific, today's ROCE was 16% five years ago but has since fallen to 12%. On top of that, the business is utilizing 21% less capital within its operations. 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. If these underlying trends continue, we wouldn't be too optimistic going forward.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 53%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
In Conclusion...
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Despite the concerning underlying trends, the stock has actually gained 1.4% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
If you want to know some of the risks facing Compumedics we've found 4 warning signs (2 shouldn't be ignored!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
