What financial metrics can indicate to us that a company is maturing or even in decline? 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 the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Valhi (NYSE:VHI), we weren't too hopeful.
Return On Capital Employed (ROCE): What Is It?
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 Valhi, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = US$69m ÷ (US$2.5b - US$379m) (Based on the trailing twelve months to June 2024).
So, Valhi has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 8.8%.
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 , check out these free graphs detailing revenue and cash flow performance of Valhi.
What Can We Tell From Valhi's ROCE Trend?
We are a bit worried about the trend of returns on capital at Valhi. To be more specific, the ROCE was 7.5% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Valhi becoming one if things continue as they have.
The Bottom Line
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 1.5% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
Valhi does have some risks, we noticed 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
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.