Be Wary Of Chemical Industries (Far East) (SGX:C05) And Its Returns On Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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 Chemical Industries (Far East) (SGX:C05), so let's see why.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Chemical Industries (Far East):

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

0.027 = S$3.6m ÷ (S$145m - S$14m) (Based on the trailing twelve months to March 2021).

Therefore, Chemical Industries (Far East) has an ROCE of 2.7%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 11%.

Check out our latest analysis for Chemical Industries (Far East)

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

So How Is Chemical Industries (Far East)'s ROCE Trending?

We are a bit worried about the trend of returns on capital at Chemical Industries (Far East). To be more specific, the ROCE was 7.0% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Chemical Industries (Far East) becoming one if things continue as they have.

On a related note, Chemical Industries (Far East) has decreased its current liabilities to 9.7% of total assets. That could partly explain why the ROCE has dropped. 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.

The Bottom Line

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. However the stock has delivered a 61% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Chemical Industries (Far East) does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is potentially serious...

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. 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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