Baazeem Trading's (TADAWUL:4051) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Baazeem Trading (TADAWUL:4051), we weren't too upbeat about how things were going.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Baazeem Trading:

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

0.16 = ر.س32m ÷ (ر.س238m - ر.س37m) (Based on the trailing twelve months to December 2020).

Therefore, Baazeem Trading has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Retail Distributors industry average of 5.2% it's much better.

See our latest analysis for Baazeem Trading

Historical performance is a great place to start when researching a stock so above you can see the gauge for Baazeem Trading's ROCE against it's prior returns. If you'd like to look at how Baazeem Trading has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We are a bit worried about the trend of returns on capital at Baazeem Trading. To be more specific, the ROCE was 23% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Baazeem Trading to turn into a multi-bagger.

On a side note, Baazeem Trading has done well to pay down its current liabilities to 15% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Baazeem Trading's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Since the stock has skyrocketed 406% over the last three years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know more about Baazeem Trading, we've spotted 2 warning signs, and 1 of them is potentially serious.

While Baazeem Trading isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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