If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at IPG Photonics (NASDAQ:IPGP), so let's see why.

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. To calculate this metric for IPG Photonics, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.076 = US$185m ÷ (US$2.7b - US$220m) (Based on the trailing twelve months to September 2023).

Thus, IPG Photonics has an ROCE of 7.6%. Ultimately, that's a low return and it under-performs the Electronic industry average of 12%.

See our latest analysis for IPG Photonics

In the above chart we have measured IPG Photonics' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering IPG Photonics here for free.

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about IPG Photonics, given the returns are trending downwards. About five years ago, returns on capital were 24%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on IPG Photonics becoming one if things continue as they have.

The Bottom Line On IPG Photonics' ROCE

In summary, it's unfortunate that IPG Photonics is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 24% 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.

Like most companies, IPG Photonics does come with some risks, and we've found 2 warning signs that you should be aware of.

While IPG Photonics may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.