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When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it’s shrinking its base of capital employed. On that note, looking into Precision Camshafts (NSE:PRECAM), we weren’t too upbeat about how things were going.
Return On Capital Employed (ROCE): What Is It?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Precision Camshafts, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.041 = ₹299m ÷ (₹11b – ₹3.7b) (Based on the trailing twelve months to September 2022).
Therefore, Precision Camshafts has an ROCE of 4.1%. In absolute terms, that’s a low return and it also under-performs the Auto Components industry average of 13%.
Check out our latest analysis for Precision Camshafts
Historical performance is a great place to start when researching a stock so above you can see the gauge for Precision Camshafts’ ROCE against it’s prior returns. If you’re interested in investigating Precision Camshafts’ past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Precision Camshafts. To be more specific, the ROCE was 7.5% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren’t as high due potentially to new competition or smaller margins. So because these trends aren’t typically conducive to creating a multi-bagger, we wouldn’t hold our breath on Precision Camshafts becoming one if things continue as they have.
On a side note, Precision Camshafts’ current liabilities have increased over the last five years to 34% of total assets, effectively distorting the ROCE to some degree. Without this increase, it’s likely that ROCE would be even lower than 4.1%. While the ratio isn’t currently too high, it’s worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Bottom Line On Precision Camshafts’ ROCE
In summary, it’s unfortunate that Precision Camshafts is generating lower returns from the same amount of capital. And, the stock has remained flat over the last five years, so investors don’t seem too impressed either. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
One more thing: We’ve identified 3 warning signs with Precision Camshafts (at least 1 which doesn’t sit too well with us) , and understanding these 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.
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Find out whether Precision Camshafts is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.
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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.
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