What financial metrics can indicate to us that a company is maturing or even in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. And from a first read, things don't look too good at Baazeem Trading (TADAWUL:4051), so let's see why.
Understanding 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. To calculate this metric for Baazeem Trading, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = ر.س29m ÷ (ر.س253m - ر.س50m) (Based on the trailing twelve months to September 2021).
Thus, Baazeem Trading has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 6.0% generated by the Retail Distributors industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Baazeem Trading, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Baazeem Trading. Unfortunately the returns on capital have diminished from the 20% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 Baazeem Trading becoming one if things continue as they have.
On a related note, Baazeem Trading has decreased its current liabilities to 20% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
What We Can Learn From Baazeem Trading's ROCE
In summary, it's unfortunate that Baazeem Trading is generating lower returns from the same amount of capital. Yet despite these poor fundamentals, the stock has gained a huge 271% over the last three 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.
Baazeem Trading does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
While Baazeem Trading 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.
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.