When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after we looked into Air New Zealand (NZSE:AIR), the trends above didn't look too great.

Return On Capital Employed (ROCE): What Is It?

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 Air New Zealand is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.046 = NZ$228m ÷ (NZ$8.5b - NZ$3.6b) (Based on the trailing twelve months to June 2024).

So, Air New Zealand has an ROCE of 4.6%. In absolute terms, that's a low return and it also under-performs the Airlines industry average of 8.9%.

View our latest analysis for Air New Zealand

Above you can see how the current ROCE for Air New Zealand compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Air New Zealand for free.

How Are Returns Trending?

There is reason to be cautious about Air New Zealand, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 6.6% that they were earning five years ago. 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. If these trends continue, we wouldn't expect Air New Zealand to turn into a multi-bagger.

On a side note, Air New Zealand's current liabilities are still rather high at 42% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 64% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing to note, we've identified 2 warning signs with Air New Zealand and understanding these should be part of your investment process.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.