Here's What's Concerning About Saudi Chemical's (TADAWUL:2230) Returns On Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Saudi Chemical (TADAWUL:2230), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

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 Saudi Chemical, this is the formula:

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

0.068 = ر.س131m ÷ (ر.س4.9b - ر.س3.0b) (Based on the trailing twelve months to September 2020).

So, Saudi Chemical has an ROCE of 6.8%. Even though it's in line with the industry average of 7.2%, it's still a low return by itself.

View our latest analysis for Saudi Chemical

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

How Are Returns Trending?

There is reason to be cautious about Saudi Chemical, given the returns are trending downwards. To be more specific, the ROCE was 18% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Saudi Chemical to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 61%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

Our Take On Saudi Chemical's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Despite the concerning underlying trends, the stock has actually gained 20% 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.

One final note, you should learn about the 3 warning signs we've spotted with Saudi Chemical (including 2 which are concerning) .

While Saudi Chemical 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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