Famous brands (JSE:FBR) could risk shrinking as a business

When researching a stock for investment purposes, what can tell us that the company is in decline? More often than not we will see a decline to return to on capital employed (ROCE) and a decrease amount capital employed. This reveals that the company is not increasing shareholder wealth because returns are falling and its net asset base is shrinking. And from a first reading, things don’t look very good to Famous brands (JSE:FBR), so let’s see why.

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. Analysts use this formula to calculate it for famous brands:

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

0.29 = R626m ÷ (R3.0b – R835m) (Based on the last twelve months to August 2021).

So, Famous Brands has a ROCE of 29%. In absolute terms, this is an excellent return and is even better than the hotel industry average of 7.2%.

Check out our latest analysis for famous brands

JSE:FBR Return on Capital Employed February 25, 2022

Historical performance is a great starting point when researching a stock. So above you can see the Famous Brands ROCE gauge compared to its past returns. If you want to see how Famous Brands have performed in the past in other metrics, you can check out this free chart of past profits, revenue and cash flow.

What can we say about the ROCE trend of famous brands?

Caution should be exercised with famous brands, as yields are on the decline. To be more precise, the ROCE was 43% five years ago, but since then it has fallen significantly. In addition to this, it should be noted that the amount of capital used within the company remained relatively stable. Companies that exhibit these attributes tend not to shrink, but they can be mature and face pressure on their margins from the competition. If these trends continue, we don’t expect Famous Brands to turn into a multi-bagger.

Similarly, Famous Brands reduced its current liabilities to 28% of total assets. This could partly explain why ROCE fell. Additionally, it may reduce some aspects of risk to the business, as the business’s suppliers or short-term creditors now fund less of its operations. Since the company is essentially funding more of its operations with its own money, one could argue that this has made the company less efficient at generating a return on investment.

In conclusion…

In summary, it is unfortunate that Famous Brands generates lower returns from the same amount of capital. It’s no surprise, then, that the stock has fallen 54% in the past five years, so it seems investors are acknowledging these changes. That being the case, unless the underlying trends return to a more positive trajectory, we would consider looking elsewhere.

If you want to know some of the risks famous brands face, we found 3 warning signs (2 are a bit of a concern!) that you should be aware of before investing here.

Famous Brands is not the only stock to generate high returns. If you want to see more, check out our free list of companies with high returns on equity with strong fundamentals.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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