Capital Allocation Trends At Orad (TLV:ORAD) Aren't Ideal

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Orad (TLV:ORAD) we aren't filled with optimism, but let's investigate further.

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 Orad, this is the formula:

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

0.17 = ₪8.4m ÷ (₪135m - ₪86m) (Based on the trailing twelve months to June 2022).

So, Orad has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 14% it's much better.

Check out the opportunities and risks within the IL Electronic industry.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Orad, check out these free graphs here.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Orad. To be more specific, the ROCE was 25% 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. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Orad to turn into a multi-bagger.

Another thing to note, Orad has a high ratio of current liabilities to total assets of 63%. 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.

The Bottom Line On Orad's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. We expect this has contributed to the stock plummeting 78% during the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing to note, we've identified 2 warning signs with Orad and understanding them should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.