What financial metrics can indicate to us that a company is maturing or even in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into GLG (ASX:GLE), the trends above didn't look too great.
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 GLG, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.008 = US$439k ÷ (US$100m - US$45m) (Based on the trailing twelve months to June 2024).
Therefore, GLG has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 9.1%.
Check out our latest analysis for GLG
Historical performance is a great place to start when researching a stock so above you can see the gauge for GLG's ROCE against it's prior returns. If you're interested in investigating GLG's past further, check out this free graph covering GLG's past earnings, revenue and cash flow.
There is reason to be cautious about GLG, given the returns are trending downwards. To be more specific, the ROCE was 7.4% 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. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on GLG becoming one if things continue as they have.
On a related note, GLG has decreased its current liabilities to 45% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
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. Long term shareholders who've owned the stock over the last three years have experienced a 34% 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 4 warning signs with GLG and understanding them 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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