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When it comes to investing, there are some useful financial indicators that can alert us when a business is potentially in trouble. A potentially declining business often exhibits two trends, one to recover on capital employed (ROCE) down, and a based capital employed which is also declining. This indicates that the company is making less profit from its investments and that its total assets are decreasing. So after taking a look at the trends within Enerpac Tool Group (NYSE: EPAC), we didn’t have too much hope.
Return on capital employed (ROCE): what is it?
For those who don’t know, ROCE is a measure of a company’s annual pre-tax profit (its return), relative to the capital employed in the company. The formula for this calculation on Enerpac Tool Group is:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.062 = US $ 44 million ÷ (US $ 843 million – US $ 134 million) (Based on the last twelve months up to May 2021).
Thereby, Enerpac Tool Group has a ROCE of 6.2%. In absolute terms, this is low efficiency and it is also below the machinery industry average of 9.6%.
See our latest review for Enerpac Tool Group
Above you can see how Enerpac Tool Group’s current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you want, you can view analyst forecasts covering Enerpac Tool Group here for free.
How are the returns evolving?
We’re a little worried about ROCE trends at Enerpac Tool Group. The company generated 8.8% of its capital five years ago, but it has since declined significantly. On top of that, Enerpac Tool Group now employs 42% less capital than five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to face competitive headwinds or to see its moat eroded. Generally, the companies that exhibit these characteristics are not the ones that tend to multiply over the long term, because statistically speaking, they have already gone through the growth phase of their life cycle.
The key to take away
In short, lower returns and diminishing amounts of capital employed in the business do not give us confidence. Despite the worrying underlying trends, the stock has actually gained 5.0% over the past five years, so investors might expect the trends to reverse. Either way, we don’t like trends as they are and if they persist we think you might find better investments elsewhere.
On a final note, we found 1 warning sign for Enerpac Tool Group that we think you should be aware of.
Although Enerpac Tool Group does not achieve the highest yield, check out this free list of companies that generate high returns on equity with strong balance sheets.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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