Capital Allocation Trends At Socovesa (SNSE:SOCOVESA) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Socovesa (SNSE:SOCOVESA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Socovesa, this is the formula:

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

0.089 = CL$37b ÷ (CL$1.0t - CL$595b) (Based on the trailing twelve months to September 2021).

So, Socovesa has an ROCE of 8.9%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 22%.

View our latest analysis for Socovesa

Historical performance is a great place to start when researching a stock so above you can see the gauge for Socovesa's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Socovesa, check out these free graphs here.

The Trend Of ROCE

In terms of Socovesa's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 17%, but since then they've fallen to 8.9%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Socovesa's current liabilities are still rather high at 59% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

In summary, we're somewhat concerned by Socovesa's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 24% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Socovesa does have some risks though, and we've spotted 2 warning signs for Socovesa that you might be interested in.

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.