What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 ktcs (KRX:058850) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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 ktcs, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.085 = ₩18b ÷ (₩385b - ₩176b) (Based on the trailing twelve months to December 2020).
Therefore, ktcs has an ROCE of 8.5%. On its own, that's a low figure but it's around the 10% average generated by the Commercial Services industry.
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're interested in investigating ktcs' past further, check out this free graph of past earnings, revenue and cash flow.
So How Is ktcs' ROCE Trending?
In terms of ktcs' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 8.5% for the last five years, and the capital employed within the business has risen 34% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
On a separate but related note, it's important to know that ktcs has a current liabilities to total assets ratio of 46%, 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.
The Bottom Line On ktcs' ROCE
As we've seen above, ktcs' returns on capital haven't increased but it is reinvesting in the business. And investors may be recognizing these trends since the stock has only returned a total of 21% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing to note, we've identified 1 warning sign with ktcs and understanding it should be part of your investment process.
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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