Yahoo Finance A. O. Smith (NYSE:AOS) Could Be Struggling To Allocate Capital
What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within A. O. Smith (NYSE:AOS), we weren't too hopeful.
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. To calculate this metric for A. O. Smith, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = US$214m ÷ (US$3.3b - US$934m) (Based on the trailing twelve months to December 2022).
Therefore, A. O. Smith has an ROCE of 8.9%. Ultimately, that's a low return and it under-performs the Building industry average of 14%.
See our latest analysis for A. O. Smith
Above you can see how the current ROCE for A. O. Smith compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for A. O. Smith.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about A. O. Smith, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 21% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on A. O. Smith becoming one if things continue as they have.
What We Can Learn From A. O. Smith's ROCE
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. In spite of that, the stock has delivered a 20% return to shareholders who held over 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.
If you want to continue researching A. O. Smith, you might be interested to know about the 2 warning signs 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.
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