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If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Triumph Group (NYSE:TGI), the trends above didn't look too great.
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 Triumph Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = US$111m ÷ (US$2.4b - US$639m) (Based on the trailing twelve months to December 2020).
Therefore, Triumph Group has an ROCE of 6.3%. In absolute terms, that's a low return and it also under-performs the Aerospace & Defense industry average of 8.5%.
Above you can see how the current ROCE for Triumph Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Triumph Group here for free.
What The Trend Of ROCE Can Tell Us
The trend of returns that Triumph Group is generating are raising some concerns. To be more specific, today's ROCE was 9.1% five years ago but has since fallen to 6.3%. In addition to that, Triumph Group is now employing 66% less capital than it was five years ago. The fact that both are shrinking is an indication that the business is going through some tough times. 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 27%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
What We Can Learn From Triumph Group's ROCE
In summary, it's unfortunate that Triumph Group is shrinking its capital base and also generating lower returns. Long term shareholders who've owned the stock over the last five years have experienced a 48% 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.
One more thing: We've identified 4 warning signs with Triumph Group (at least 1 which can't be ignored) , and understanding them would certainly be useful.
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.
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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