If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. 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 Ashland (NYSE:ASH), the trends above didn't look too great.
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. To calculate this metric for Ashland, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.021 = US$114m ÷ (US$5.9b - US$414m) (Based on the trailing twelve months to December 2023).
Thus, Ashland has an ROCE of 2.1%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 10%.
In the above chart we have measured Ashland's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Ashland here for free.
So How Is Ashland's ROCE Trending?
We are a bit anxious about the trends of ROCE at Ashland. Unfortunately, returns have declined substantially over the last five years to the 2.1% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 23% over that same period. The fact that both are shrinking is an indication that the business is going through some tough times. 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.
In Conclusion...
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. In spite of that, the stock has delivered a 28% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
On a final note, we've found 2 warning signs for Ashland that we think you should be aware of.
While Ashland 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.
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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.