Caffyns (LON: CFYN) will look to straighten his returns

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Ignoring a company’s stock price, what are the underlying trends that tell us that a company is past the growth stage? Typically we will see the trend of both return on capital employed (ROCE) declining and this generally coincides with a decrease amount capital employed. This combination can tell you that the business not only invests less, but earns less on what it invests. So after taking a look at the trends within Caffyn (LON: CFYN), we didn’t have too much hope.

Understanding Return on Capital Employed (ROCE)

Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. The formula for this calculation on Caffyns is:

Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)

0.058 = £ 3.1million (£ 94million – £ 41million) (Based on the last twelve months up to March 2021).

Therefore, Caffyns has a ROCE of 5.8%. At the end of the day, that’s a low return, and it’s 10% below the specialty retail industry average.

See our latest review for Caffyns

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Although the past is not representative of the future, it can be useful to know the historical performance of a company, which is why we have this graph above. If you want to dive into the history of Caffyns earnings, income and cash flow, check out these free graphics here.

So how is Caffyns’ ROCE changing?

At the level of Caffyns historical ROCE movements, the trend does not inspire confidence. To be more precise, the ROCE was 8.4% five years ago, but since then it has fallen noticeably. And on the capital employed front, the company is using roughly the same amount of capital as it was back in the day. As returns decline and the company has the same number of assets employed, this may suggest that it is a mature company that has not seen much growth in the past five years. So, because these trends are generally not conducive to building a multi-bagger, we won’t be holding our breath on Caffyns becoming one if things continue the way they have.

By the way, Caffyns’ current liabilities are still quite high at 44% of total assets. This effectively means that suppliers (or short-term creditors) fund a large part of the business, so just be aware that this can introduce some elements of risk. While this isn’t necessarily a bad thing, it can be beneficial if this ratio is lower.

The bottom line

Ultimately, the downward trend in returns on the same amount of capital is generally not an indication that we are considering a growth stock. Long-term shareholders who held the stock for the past five years experienced a 14% depreciation of their investment, so it looks like the market might not like these trends either. With underlying trends not being great in these areas, we would consider looking elsewhere.

One more thing: we have identified 4 warning signs with Caffyns (at least 2 who are a bit rude), and understanding them would definitely help.

For those who like to invest in solid companies, Check it out free list of companies with strong balance sheets and high returns on equity.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.

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