When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Scotts Miracle-Gro (NYSE:SMG), we've spotted some signs that it could be struggling, so let's investigate.
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 Scotts Miracle-Gro:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = US$259m ÷ (US$3.9b - US$1.1b) (Based on the trailing twelve months to March 2024).
So, Scotts Miracle-Gro has an ROCE of 9.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.8%.
In the above chart we have measured Scotts Miracle-Gro'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 Scotts Miracle-Gro for free.
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at Scotts Miracle-Gro. To be more specific, the ROCE was 14% 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 Scotts Miracle-Gro becoming one if things continue as they have.
What We Can Learn From Scotts Miracle-Gro's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 20% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Scotts Miracle-Gro (of which 1 doesn't sit too well with us!) that you should know about.
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.
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