When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Hallador Energy (NASDAQ:HNRG), the trends above didn't look too great.
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 Hallador Energy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.022 = US$9.0m ÷ (US$595m - US$196m) (Based on the trailing twelve months to June 2024).
So, Hallador Energy has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 12%.
Above you can see how the current ROCE for Hallador Energy compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Hallador Energy .
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at Hallador Energy. About five years ago, returns on capital were 4.8%, 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 Hallador Energy becoming one if things continue as they have.
On a side note, Hallador Energy's current liabilities have increased over the last five years to 33% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.2%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
In Conclusion...
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 28% 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.
One more thing to note, we've identified 2 warning signs with Hallador Energy and understanding them should be part of your investment process.
While Hallador Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.