To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into Gadang Holdings Berhad (KLSE:GADANG), we weren't too upbeat about how things were going.
Understanding 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. Analysts use this formula to calculate it for Gadang Holdings Berhad:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = RM71m ÷ (RM1.6b - RM383m) (Based on the trailing twelve months to May 2022).
Thus, Gadang Holdings Berhad has an ROCE of 6.0%. On its own, that's a low figure but it's around the 5.1% average generated by the Construction industry.
Above you can see how the current ROCE for Gadang Holdings 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 Gadang Holdings Berhad.
What Does the ROCE Trend For Gadang Holdings Berhad Tell Us?
We are a bit worried about the trend of returns on capital at Gadang Holdings Berhad. Unfortunately the returns on capital have diminished from the 13% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Gadang Holdings Berhad becoming one if things continue as they have.
Our Take On Gadang Holdings Berhad's ROCE
In summary, it's unfortunate that Gadang Holdings Berhad is generating lower returns from the same amount of capital. This could explain why the stock has sunk a total of 72% in the last five years. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Gadang Holdings Berhad (including 1 which is potentially serious) .
While Gadang Holdings 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.
Valuation is complex, but we're helping make it simple.
Find out whether Gadang Holdings Berhad is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.
Gadang Holdings Berhad
Gadang Holdings Berhad, an investment holding company, engages in civil engineering and construction, property development, water supply, and mechanical and electrical engineering businesses in Malaysia, Indonesia, and Singapore.
Flawless balance sheet with reasonable growth potential.