Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Emerald Holding (NYSE:EEX), so let's see why.
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 Emerald Holding is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = US$18m ÷ (US$1.1b - US$232m) (Based on the trailing twelve months to September 2023).
Therefore, Emerald Holding has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Media industry average of 8.1%.
Above you can see how the current ROCE for Emerald Holding 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 Emerald Holding for free.
What The Trend Of ROCE Can Tell Us
The trend of returns that Emerald Holding is generating are raising some concerns. To be more specific, today's ROCE was 8.0% five years ago but has since fallen to 2.2%. In addition to that, Emerald Holding is now employing 42% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. 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.
What We Can Learn From Emerald Holding's ROCE
In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Investors haven't taken kindly to these developments, since the stock has declined 54% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you'd like to know more about Emerald Holding, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.
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.