Some Investors May Be Worried About Downer EDI's (ASX:DOW) Returns On Capital

Simply Wall St · 08/30 23:20

When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Basically the company is earning less on its investments and it is also reducing its total assets. Having said that, after a brief look, Downer EDI (ASX:DOW) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

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 Downer EDI, this is the formula:

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

0.058 = AU$240m ÷ (AU$6.7b - AU$2.7b) (Based on the trailing twelve months to June 2024).

So, Downer EDI has an ROCE of 5.8%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 12%.

See our latest analysis for Downer EDI

roce
ASX:DOW Return on Capital Employed August 30th 2024

Above you can see how the current ROCE for Downer EDI compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Downer EDI .

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Downer EDI. About five years ago, returns on capital were 8.1%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Downer EDI becoming one if things continue as they have.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 14% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 1 warning sign for Downer EDI you'll probably want to know about.

While Downer EDI may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.