Should You Be Impressed By ACO Group Berhad's (KLSE:ACO) Returns on Capital?

What are the early trends we should look for to identify a stock that could 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. Having said that, from a first glance at ACO Group Berhad (KLSE:ACO) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

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 ACO Group Berhad, this is the formula:

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

0.087 = RM6.6m ÷ (RM130m - RM54m) (Based on the trailing twelve months to November 2020).

Therefore, ACO Group Berhad has an ROCE of 8.7%. In absolute terms, that's a low return, but it's much better than the Trade Distributors industry average of 6.2%.

See our latest analysis for ACO Group Berhad

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 ACO Group Berhad, check out these free graphs here.

What Can We Tell From ACO Group Berhad's ROCE Trend?

On the surface, the trend of ROCE at ACO Group Berhad doesn't inspire confidence. To be more specific, ROCE has fallen from 18% over the last three years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, ACO Group Berhad has decreased its current liabilities to 41% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On ACO Group Berhad's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for ACO Group Berhad have fallen, meanwhile the business is employing more capital than it was three years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 102%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know about the risks facing ACO Group Berhad, we've discovered 3 warning signs that you should be aware of.

While ACO Group Berhad isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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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