When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. On that note, looking into SKY Network Television (NZSE:SKT), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on SKY Network Television is:

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

0.067 = NZ$30m ÷ (NZ$626m - NZ$170m) (Based on the trailing twelve months to December 2024).

Therefore, SKY Network Television has an ROCE of 6.7%. Even though it's in line with the industry average of 6.7%, it's still a low return by itself.

See our latest analysis for SKY Network Television

Above you can see how the current ROCE for SKY Network Television 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 SKY Network Television for free.

What Can We Tell From SKY Network Television's ROCE Trend?

In terms of SKY Network Television's historical ROCE trend, it isn't fantastic. Unfortunately, returns have declined substantially over the last five years to the 6.7% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 32% over that same period. 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. 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.

The Key Takeaway

In summary, it's unfortunate that SKY Network Television is shrinking its capital base and also generating lower returns. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 103%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 2 warning signs with SKY Network Television 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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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.