Capital Allocation Trends At Saudi Cement (TADAWUL:3030) Aren't Ideal

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. 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 Cement (TADAWUL:3030), we've spotted some signs that it could be struggling, so let's investigate.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Saudi Cement, this is the formula:

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

0.11 = ر.س280m ÷ (ر.س3.5b - ر.س886m) (Based on the trailing twelve months to March 2022).

Therefore, Saudi Cement has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 5.5% generated by the Basic Materials industry.

View our latest analysis for Saudi Cement

In the above chart we have measured Saudi Cement's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Saudi Cement.

So How Is Saudi Cement's ROCE Trending?

The trend of returns that Saudi Cement is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 11% we see today. In addition to that, Saudi Cement is now employing 24% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

Our Take On Saudi Cement's ROCE

To see Saudi Cement reducing the capital employed in the business in tandem with diminishing returns, is concerning. Yet despite these concerning fundamentals, the stock has performed strongly with a 59% 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.

Like most companies, Saudi Cement does come with some risks, and we've found 1 warning sign that you should be aware of.

While Saudi Cement 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. 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.