Returns On Capital - An Important Metric For Namkwang Engineering & Construction (KRX:001260)

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. With that in mind, we've noticed some promising trends at Namkwang Engineering & Construction (KRX:001260) so let's look a bit deeper.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for Namkwang Engineering & Construction, this is the formula:

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

0.14 = ₩9.2b ÷ (₩251b - ₩183b) (Based on the trailing twelve months to September 2020).

So, Namkwang Engineering & Construction has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 9.0% it's much better.

Check out our latest analysis for Namkwang Engineering & Construction

Historical performance is a great place to start when researching a stock so above you can see the gauge for Namkwang Engineering & Construction's ROCE against it's prior returns. If you'd like to look at how Namkwang Engineering & Construction has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We're delighted to see that Namkwang Engineering & Construction is reaping rewards from its investments and has now broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 14%, which is always encouraging. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

Another thing to note, Namkwang Engineering & Construction has a high ratio of current liabilities to total assets of 73%. 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.

The Bottom Line

As discussed above, Namkwang Engineering & Construction appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 27% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing to note, we've identified 1 warning sign with Namkwang Engineering & Construction and understanding it should be part of your investment process.

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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