What Do The Returns On Capital At Favelle Favco Berhad (KLSE:FAVCO) Tell Us?

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Favelle Favco Berhad (KLSE:FAVCO) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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

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

0.10 = RM81m ÷ (RM1.3b - RM510m) (Based on the trailing twelve months to September 2020).

Thus, Favelle Favco Berhad has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 10%.

See our latest analysis for Favelle Favco Berhad

In the above chart we have measured Favelle Favco Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Favelle Favco Berhad here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Favelle Favco Berhad doesn't inspire confidence. Over the last five years, returns on capital have decreased to 10% from 22% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Favelle Favco Berhad has decreased its current liabilities to 39% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Favelle Favco Berhad's ROCE

In summary, Favelle Favco Berhad is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 6.8% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Favelle Favco Berhad could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

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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