What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Foot Locker (NYSE:FL) we aren't filled with optimism, but let's investigate further.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Foot Locker is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.025 = US$138m ÷ (US$6.9b - US$1.4b) (Based on the trailing twelve months to May 2024).
So, Foot Locker has an ROCE of 2.5%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.
In the above chart we have measured Foot Locker'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 Foot Locker for free.
What Can We Tell From Foot Locker's ROCE Trend?
There is reason to be cautious about Foot Locker, given the returns are trending downwards. About five years ago, returns on capital were 13%, 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. 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 Foot Locker becoming one if things continue as they have.
In Conclusion...
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 30% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
If you're still interested in Foot Locker it's worth checking out our FREE intrinsic value approximation for FL to see if it's trading at an attractive price in other respects.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com