To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, PermRock Royalty Trust (NYSE:PRT) we aren't filled with optimism, but let's investigate further.
Understanding 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 PermRock Royalty Trust:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = US$5.7m ÷ (US$86m - US$610k) (Based on the trailing twelve months to September 2021).
So, PermRock Royalty Trust has an ROCE of 6.6%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 9.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for PermRock Royalty Trust's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of PermRock Royalty Trust, check out these free graphs here.
What Can We Tell From PermRock Royalty Trust's ROCE Trend?
In terms of PermRock Royalty Trust's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 12% two years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last two years. If these trends continue, we wouldn't expect PermRock Royalty Trust to turn into a multi-bagger.
Our Take On PermRock Royalty Trust's ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 17% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
PermRock Royalty Trust does have some risks though, and we've spotted 2 warning signs for PermRock Royalty Trust that you might be interested in.
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.
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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