Be Wary Of Favelle Favco Berhad (KLSE:FAVCO) And Its Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Favelle Favco Berhad (KLSE:FAVCO) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Favelle Favco Berhad is:

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

0.048 = RM40m ÷ (RM1.3b - RM512m) (Based on the trailing twelve months to December 2020).

Thus, Favelle Favco Berhad has an ROCE of 4.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.1%.

View our latest analysis for Favelle Favco Berhad

Above you can see how the current ROCE for Favelle Favco Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Favelle Favco Berhad.

So How Is Favelle Favco Berhad's ROCE Trending?

In terms of Favelle Favco Berhad's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.8% from 20% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Favelle Favco Berhad has decreased its current liabilities to 38% 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. 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 Bottom Line

We're a bit apprehensive about Favelle Favco Berhad because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 12% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a separate note, we've found 3 warning signs for Favelle Favco Berhad you'll probably want to know about.

While Favelle Favco Berhad 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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