Capital Allocation Trends At Paragon Fine And Speciality Chemical (NSE:PARAGON) Aren't Ideal

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Paragon Fine And Speciality Chemical (NSE:PARAGON) and its ROCE trend, we weren't exactly thrilled.

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 Paragon Fine And Speciality Chemical, this is the formula:

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

0.14 = ₹129m ÷ (₹1.0b - ₹103m) (Based on the trailing twelve months to September 2024).

Thus, Paragon Fine And Speciality Chemical has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Chemicals industry.

Check out our latest analysis for Paragon Fine And Speciality Chemical

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'd like to look at how Paragon Fine And Speciality Chemical has performed in the past in other metrics, you can view this free graph of Paragon Fine And Speciality Chemical's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Paragon Fine And Speciality Chemical, we didn't gain much confidence. To be more specific, ROCE has fallen from 27% over the last three years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Paragon Fine And Speciality Chemical has decreased its current liabilities to 10% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

We're a bit apprehensive about Paragon Fine And Speciality Chemical because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 49% from where it was year ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Paragon Fine And Speciality Chemical does have some risks, we noticed 2 warning signs (and 1 which is significant) we think you should know about.

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.