If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Matthews International (NASDAQ:MATW), we weren't too upbeat about how things were going.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Matthews International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = US$69m ÷ (US$2.0b - US$354m) (Based on the trailing twelve months to September 2021).
Thus, Matthews International has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 8.6%.
In the above chart we have measured Matthews International'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 Matthews International here for free.
What Does the ROCE Trend For Matthews International Tell Us?
We are a bit worried about the trend of returns on capital at Matthews International. To be more specific, the ROCE was 6.7% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Matthews International becoming one if things continue as they have.
What We Can Learn From Matthews International's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 43% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Matthews International does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...
While Matthews International isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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