What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at TBK & Sons Holdings (HKG:1960) 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?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for TBK & Sons Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0068 = RM991k ÷ (RM171m - RM26m) (Based on the trailing twelve months to December 2020).
So, TBK & Sons Holdings has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Energy Services industry average of 4.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for TBK & Sons Holdings' ROCE against it's prior returns. If you're interested in investigating TBK & Sons Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at TBK & Sons Holdings doesn't inspire confidence. Around four years ago the returns on capital were 49%, but since then they've fallen to 0.7%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, TBK & Sons Holdings has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On TBK & Sons Holdings' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for TBK & Sons Holdings have fallen, meanwhile the business is employing more capital than it was four years ago. Since the stock has skyrocketed 123% over the last year, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
TBK & Sons Holdings does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
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