Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at MeridianLink (NYSE:MLNK), so let's see why.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for MeridianLink, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.024 = US$21m ÷ (US$971m - US$74m) (Based on the trailing twelve months to March 2024).

Therefore, MeridianLink has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Software industry average of 7.3%.

Above you can see how the current ROCE for MeridianLink compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering MeridianLink for free.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at MeridianLink. To be more specific, the ROCE was 3.7% four years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 MeridianLink becoming one if things continue as they have.

The Key Takeaway

In summary, it's unfortunate that MeridianLink is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 8.3% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to continue researching MeridianLink, you might be interested to know about the 1 warning sign that our analysis has discovered.

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.