Be Wary Of Saudi Ceramic (TADAWUL:2040) And Its Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at Saudi Ceramic (TADAWUL:2040), we've spotted some signs that it could be struggling, so let's investigate.

What is 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 Saudi Ceramic, this is the formula:

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

0.059 = ر.س127m ÷ (ر.س2.8b - ر.س623m) (Based on the trailing twelve months to December 2020).

Thus, Saudi Ceramic has an ROCE of 5.9%. In absolute terms, that's a low return and it also under-performs the Building industry average of 9.0%.

Check out our latest analysis for Saudi Ceramic

In the above chart we have measured Saudi Ceramic's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Saudi Ceramic Tell Us?

We are a bit worried about the trend of returns on capital at Saudi Ceramic. About five years ago, returns on capital were 11%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Saudi Ceramic to turn into a multi-bagger.

In Conclusion...

In summary, it's unfortunate that Saudi Ceramic is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 88% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing, we've spotted 1 warning sign facing Saudi Ceramic that you might find interesting.

While Saudi Ceramic may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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