When researching a stock for investment, what can tell us that the company is 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. And from a first read, things don't look too good at Zicom Group (ASX:ZGL), so let's see why.
What is 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 Zicom Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = S$1.0m ÷ (S$145m - S$67m) (Based on the trailing twelve months to June 2020).
So, Zicom Group has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Machinery industry average of 11%.
View our latest analysis for Zicom Group
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're interested in investigating Zicom Group's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Zicom Group's historical ROCE trend, it isn't fantastic. The company used to generate 2.0% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 20% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 46%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.3%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
What We Can Learn From Zicom Group's ROCE
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 69% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing Zicom Group we've found 4 warning signs (3 are significant!) that you should be aware of before investing here.
While Zicom Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.