How Has Saudi Chemical (TADAWUL:2230) Allocated Its Capital?

When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at Saudi Chemical (TADAWUL:2230), we've spotted some signs that it could be struggling, so let's investigate.

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. Analysts use this formula to calculate it for Saudi Chemical:

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).

Therefore, Saudi Chemical has an ROCE of 6.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.2%.

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

What Can We Tell From Saudi Chemical's ROCE Trend?

We are a bit worried about the trend of returns on capital at Saudi Chemical. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Saudi Chemical becoming one if things continue as they have.

On a side note, Saudi Chemical's current liabilities have increased over the last five years to 61% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line 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. And, the stock has remained flat over the last five years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Saudi Chemical, we've spotted 3 warning signs, and 2 of them are a bit 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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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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