Be Wary Of Israel (TLV:ILCO) And Its Returns On Capital

What underlying fundamental trends can indicate that a company might be in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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 Israel (TLV:ILCO), we weren't too hopeful.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Israel, this is the formula:

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

0.011 = US$95m ÷ (US$11b - US$2.3b) (Based on the trailing twelve months to September 2020).

Therefore, Israel has an ROCE of 1.1%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 15%.

View our latest analysis for Israel

Historical performance is a great place to start when researching a stock so above you can see the gauge for Israel's ROCE against it's prior returns. If you'd like to look at how Israel has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Israel. Unfortunately the returns on capital have diminished from the 13% 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 Israel becoming one if things continue as they have.

The Bottom Line

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. Despite the concerning underlying trends, the stock has actually gained 28% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Israel does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are concerning...

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. 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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