The Returns On Capital At Salungano Group (JSE:SLG) Don't Inspire Confidence

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Salungano Group (JSE:SLG) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for Salungano Group, this is the formula:

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

0.05 = R123m ÷ (R4.6b - R2.1b) (Based on the trailing twelve months to September 2021).

Thus, Salungano Group has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 13%.

Check out our latest analysis for Salungano Group

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 Salungano Group, check out these free graphs here.

So How Is Salungano Group's ROCE Trending?

On the surface, the trend of ROCE at Salungano Group doesn't inspire confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 5.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

Another thing to note, Salungano Group has a high ratio of current liabilities to total assets of 45%. 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...

In summary, despite lower returns in the short term, we're encouraged to see that Salungano Group is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 22% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 6 warning signs we've spotted with Salungano Group (including 2 which make us uncomfortable) .

While Salungano Group 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.

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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.