When researching a stock for investment, what can tell us that the company is in decline? 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. 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. On that note, looking into Teradata (NYSE:TDC), we weren't too upbeat about how things were going.
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. The formula for this calculation on Teradata is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = US$21m ÷ (US$2.1b - US$895m) (Based on the trailing twelve months to September 2020).
Thus, Teradata has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Software industry average of 9.6%.
Above you can see how the current ROCE for Teradata 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 Teradata here for free.
So How Is Teradata's ROCE Trending?
In terms of Teradata's historical ROCE trend, it isn't fantastic. Unfortunately, returns have declined substantially over the last five years to the 1.7% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 31% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 42%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 1.7%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
Our Take On Teradata's ROCE
To see Teradata reducing the capital employed in the business in tandem with diminishing returns, is concerning. In spite of that, the stock has delivered a 13% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
One final note, you should learn about the 5 warning signs we've spotted with Teradata (including 2 which are significant) .
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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