To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within Rocky Mountain Chocolate Factory (NASDAQ:RMCF), we weren't too hopeful.
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. Analysts use this formula to calculate it for Rocky Mountain Chocolate Factory:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.027 = US$590k ÷ (US$27m - US$5.7m) (Based on the trailing twelve months to May 2022).
So, Rocky Mountain Chocolate Factory has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Food industry average of 9.5%.
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 want to delve into the historical earnings, revenue and cash flow of Rocky Mountain Chocolate Factory, check out these free graphs here.
What Does the ROCE Trend For Rocky Mountain Chocolate Factory Tell Us?
In terms of Rocky Mountain Chocolate Factory's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 26% 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. If these trends continue, we wouldn't expect Rocky Mountain Chocolate Factory to turn into a multi-bagger.
The Key Takeaway
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. Long term shareholders who've owned the stock over the last five years have experienced a 38% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we found 2 warning signs for Rocky Mountain Chocolate Factory (1 is significant) 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here