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. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Vmoto (ASX:VMT) we aren't filled with optimism, but let's investigate further.
What is Return On Capital Employed (ROCE)?
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. The formula for this calculation on Vmoto is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = AU$2.6m ÷ (AU$42m - AU$8.0m) (Based on the trailing twelve months to December 2020).
So, Vmoto has an ROCE of 7.7%. On its own, that's a low figure but it's around the 7.2% average generated by the Auto industry.
In the above chart we have measured Vmoto's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
There is reason to be cautious about Vmoto, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 11% that they were earning five years ago. 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 Vmoto becoming one if things continue as they have.
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Since the stock has skyrocketed 145% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
If you want to continue researching Vmoto, you might be interested to know about the 2 warning signs that our analysis has discovered.
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.
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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