If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into ADAMA (SZSE:000553), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on ADAMA is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.011 = CN¥410m ÷ (CN¥55b - CN¥18b) (Based on the trailing twelve months to March 2024).
So, ADAMA has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.
Above you can see how the current ROCE for ADAMA compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for ADAMA .
What Does the ROCE Trend For ADAMA Tell Us?
There is reason to be cautious about ADAMA, given the returns are trending downwards. About five years ago, returns on capital were 6.8%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect ADAMA to turn into a multi-bagger.
In Conclusion...
In summary, it's unfortunate that ADAMA is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 53% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 1 warning sign facing ADAMA that you might find interesting.
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.
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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.