Favelle Favco Berhad (KLSE:FAVCO) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Favelle Favco Berhad (KLSE:FAVCO), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Favelle Favco Berhad:

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

0.076 = RM65m ÷ (RM1.3b - RM477m) (Based on the trailing twelve months to December 2021).

So, Favelle Favco Berhad has an ROCE of 7.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.

Check out 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.

What Does the ROCE Trend For Favelle Favco Berhad Tell Us?

On the surface, the trend of ROCE at Favelle Favco Berhad doesn't inspire confidence. To be more specific, ROCE has fallen from 13% 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, Favelle Favco Berhad has decreased its current liabilities to 36% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Favelle Favco Berhad's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Favelle Favco Berhad is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 48% to shareholders over the last five years. 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.

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

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.