If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 TBK & Sons Holdings (HKG:1960) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for TBK & Sons Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = RM17m ÷ (RM183m - RM38m) (Based on the trailing twelve months to June 2020).
Thus, TBK & Sons Holdings has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 11% generated by the Energy Services industry.
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.
So How Is TBK & Sons Holdings' ROCE Trending?
In terms of TBK & Sons Holdings' historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 26%, but since then they've fallen to 12%. 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 side note, TBK & Sons Holdings has done well to pay down its current liabilities to 21% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In summary, we're somewhat concerned by TBK & Sons Holdings' diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last year. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a separate note, we've found 1 warning sign for TBK & Sons Holdings you'll probably want to know about.
While TBK & Sons Holdings 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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