What financial metrics can indicate to us that a company is maturing or even in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Covenant Logistics Group (NASDAQ:CVLG) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Covenant Logistics Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = US$40m ÷ (US$664m - US$179m) (Based on the trailing twelve months to June 2021).
Therefore, Covenant Logistics Group has an ROCE of 8.2%. In absolute terms, that's a low return and it also under-performs the Transportation industry average of 11%.
In the above chart we have measured Covenant Logistics Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
There is reason to be cautious about Covenant Logistics Group, given the returns are trending downwards. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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. If these trends continue, we wouldn't expect Covenant Logistics Group to turn into a multi-bagger.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 27%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 8.2%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Key Takeaway
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 must expect better things on the horizon though because the stock has risen 27% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
While Covenant Logistics Group doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
While Covenant Logistics Group 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.
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.
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