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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. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Perion Network (NASDAQ:PERI), we've spotted some signs that it could be struggling, so let's investigate.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Perion Network, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = US$10m ÷ (US$290m - US$81m) (Based on the trailing twelve months to June 2020).
So, Perion Network has an ROCE of 4.9%. Ultimately, that's a low return and it under-performs the Media industry average of 9.6%.
Above you can see how the current ROCE for Perion Network compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Perion Network.
What The Trend Of ROCE Can Tell Us
In terms of Perion Network's historical ROCE trend, it isn't fantastic. The company used to generate 24% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 31% 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. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 28%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line On Perion Network's ROCE
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was five years ago. Unless these trends revert to a more positive trajectory, we would look elsewhere.
If you'd like to know about the risks facing Perion Network, we've discovered 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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