Salungano Group (JSE:SLG) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Salungano Group (JSE:SLG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Salungano Group:

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

0.043 = R109m ÷ (R4.4b - R1.9b) (Based on the trailing twelve months to March 2022).

Therefore, Salungano Group has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 14%.

See our latest analysis for Salungano Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Salungano Group's ROCE against it's prior returns. If you're interested in investigating Salungano Group's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Salungano Group Tell Us?

In terms of Salungano Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 4.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that Salungano Group has a current liabilities to total assets ratio of 43%, 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Salungano Group. And there could be an opportunity here if other metrics look good too, because the stock has declined 53% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we found 5 warning signs for Salungano Group (3 can't be ignored) you should be aware of.

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. 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.