Elm (TADAWUL:7203) Is Very Good At Capital Allocation

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Elm's (TADAWUL:7203) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Elm, this is the formula:

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

0.30 = ر.س1.2b ÷ (ر.س7.3b - ر.س3.2b) (Based on the trailing twelve months to September 2023).

So, Elm has an ROCE of 30%. While that is an outstanding return, the rest of the IT industry generates similar returns, on average.

See our latest analysis for Elm

In the above chart we have measured Elm'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 Elm.

What Does the ROCE Trend For Elm Tell Us?

Investors would be pleased with what's happening at Elm. Over the last five years, returns on capital employed have risen substantially to 30%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 180%. So we're very much inspired by what we're seeing at Elm thanks to its ability to profitably reinvest capital.

On a separate but related note, it's important to know that Elm has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

All in all, it's terrific to see that Elm is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last year, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.