Returns On Capital Signal Tricky Times Ahead For Econframe Berhad (KLSE:EFRAME)

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. 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, while the ROCE is currently high for Econframe Berhad (KLSE:EFRAME), we aren't jumping out of our chairs because returns are decreasing.

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 Econframe Berhad, this is the formula:

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

0.20 = RM15m ÷ (RM81m - RM6.1m) (Based on the trailing twelve months to February 2023).

Thus, Econframe Berhad has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Building industry average of 6.4%.

Check out our latest analysis for Econframe Berhad

Historical performance is a great place to start when researching a stock so above you can see the gauge for Econframe Berhad's ROCE against it's prior returns. If you're interested in investigating Econframe Berhad's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Econframe Berhad's ROCE Trend?

On the surface, the trend of ROCE at Econframe Berhad doesn't inspire confidence. Historically returns on capital were even higher at 29%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Econframe Berhad has decreased its current liabilities to 7.5% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Key Takeaway

While returns have fallen for Econframe Berhad in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 99% to shareholders over the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One final note, you should learn about the 3 warning signs we've spotted with Econframe Berhad (including 1 which makes us a bit uncomfortable) .

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.