When researching a stock for investment, what can tell us that the company is in decline? More often than not, we’ll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Franklin Covey (NYSE:FC), we’ve spotted some signs that it could be struggling, so let’s investigate.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Franklin Covey:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.061 = US$6.0m ÷ (US$199m – US$101m) (Based on the trailing twelve months to February 2021).
So, Franklin Covey has an ROCE of 6.1%. In absolute terms, that’s a low return and it also under-performs the Professional Services industry average of 10%.
Above you can see how the current ROCE for Franklin Covey compares to its prior returns on capital, but there’s only so much you can tell from the past.
So How Is Franklin Covey’s ROCE Trending?
The trend of ROCE at Franklin Covey is showing some signs of weakness. The company used to generate 14% on its capital five years ago but it has since fallen noticeably. What’s equally concerning is that the amount of capital deployed in the business has shrunk by 30% over that same period. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. 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.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 51%, which has impacted the ROCE. If current liabilities hadn’t increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company’s suppliers or short-term creditors, which can bring some risks of its own.
What We Can Learn From Franklin Covey’s ROCE
In summary, it’s unfortunate that Franklin Covey is shrinking its capital base and also generating lower returns. The market must be rosy on the stock’s future because even though the underlying trends aren’t too encouraging, the stock has soared 103%. In any case, the current underlying trends don’t bode well for long term performance so unless they reverse, we’d start looking elsewhere.
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