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. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Grammer (ETR:GMM), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Grammer, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.047 = €39m ÷ (€1.6b - €747m) (Based on the trailing twelve months to June 2024).

Therefore, Grammer has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 8.6%.

See our latest analysis for Grammer

In the above chart we have measured Grammer's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Grammer .

What Can We Tell From Grammer's ROCE Trend?

We are a bit worried about the trend of returns on capital at Grammer. To be more specific, the ROCE was 10% five 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. 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 Grammer becoming one if things continue as they have.

Another thing to note, Grammer has a high ratio of current liabilities to total assets of 47%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Grammer's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. This could explain why the stock has sunk a total of 73% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.