Zahrat Al Waha For Trading (TADAWUL:3007) May Have Issues Allocating Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. And from a first read, things don't look too good at Zahrat Al Waha For Trading (TADAWUL:3007), so let's see why.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Zahrat Al Waha For Trading:

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

0.19 = ر.س60m ÷ (ر.س641m - ر.س319m) (Based on the trailing twelve months to March 2022).

Thus, Zahrat Al Waha For Trading has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 9.6% generated by the Packaging industry.

See our latest analysis for Zahrat Al Waha For Trading

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

The Trend Of ROCE

There is reason to be cautious about Zahrat Al Waha For Trading, given the returns are trending downwards. About five years ago, returns on capital were 23%, 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 Zahrat Al Waha For Trading to turn into a multi-bagger.

On a side note, Zahrat Al Waha For Trading's current liabilities have increased over the last five years to 50% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 19%. 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.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these concerning fundamentals, the stock has performed strongly with a 41% return over the last three years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Zahrat Al Waha For Trading (including 1 which shouldn't be ignored) .

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.