When researching a stock for investment, what can tell us that the company is in decline? 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 the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Chemical Industries (Far East) (SGX:C05) we aren't filled with optimism, but let's investigate further.
Return On Capital Employed (ROCE): What is it?
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. 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)
0.05 = S$6.5m ÷ (S$143m - S$13m) (Based on the trailing twelve months to September 2020).
Therefore, Chemical Industries (Far East) has an ROCE of 5.0%. On its own, that's a low figure but it's around the 6.1% average generated by the Chemicals 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 Chemical Industries (Far East), check out these free graphs here.
So How Is Chemical Industries (Far East)'s ROCE Trending?
There is reason to be cautious about Chemical Industries (Far East), given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 11% 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. 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. If these trends continue, we wouldn't expect Chemical Industries (Far East) to turn into a multi-bagger.
What We Can Learn From Chemical Industries (Far East)'s ROCE
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 79% 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.
If you'd like to know more about Chemical Industries (Far East), we've spotted 3 warning signs, and 1 of them is concerning.
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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