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Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that’s often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don’t look too good at Visteon (NASDAQ:VC), so let’s see why.
Understanding Return On Capital Employed (ROCE)
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Visteon:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.042 = US$61m ÷ (US$2.3b – US$824m) (Based on the trailing twelve months to December 2020).
So, Visteon has an ROCE of 4.2%. Ultimately, that’s a low return and it under-performs the Auto Components industry average of 9.3%.
View our latest analysis for Visteon
In the above chart we have measured Visteon’s 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 Visteon here for free.
What Can We Tell From Visteon’s ROCE Trend?
In terms of Visteon’s historical ROCE trend, it isn’t fantastic. The company used to generate 9.8% on its capital five years ago but it has since fallen noticeably. In addition to that, Visteon is now employing 24% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn’t be too optimistic going forward.
On a side note, Visteon has done well to pay down its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business’ efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On Visteon’s ROCE
To see Visteon reducing the capital employed in the business in tandem with diminishing returns, is concerning. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 53% return. In any case, the current underlying trends don’t bode well for long term performance so unless they reverse, we’d start looking elsewhere.
One more thing to note, we’ve identified 1 warning sign with Visteon and understanding it should be part of your investment process.
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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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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