To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. So after glancing at the trends within Goodyear Tire & Rubber (NASDAQ:GT), we weren't too hopeful.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Goodyear Tire & Rubber:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.004 = US$45m ÷ (US$17b - US$5.3b) (Based on the trailing twelve months to March 2021).
Therefore, Goodyear Tire & Rubber has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 11%.
Above you can see how the current ROCE for Goodyear Tire & Rubber 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 Goodyear Tire & Rubber here for free.
What The Trend Of ROCE Can Tell Us
In terms of Goodyear Tire & Rubber's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 14%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Goodyear Tire & Rubber to turn into a multi-bagger.
In Conclusion...
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 20% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 2 warning signs facing Goodyear Tire & Rubber that you might find interesting.
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.
This article by Simply Wall St is general in nature. 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.
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