Gamuda Berhad's (KLSE:GAMUDA) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. On that note, looking into Gamuda Berhad (KLSE:GAMUDA), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Gamuda Berhad is:

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

0.035 = RM493m ÷ (RM20b - RM6.3b) (Based on the trailing twelve months to July 2022).

Therefore, Gamuda Berhad has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Construction industry average of 5.5%.

Our analysis indicates that GAMUDA is potentially undervalued!

In the above chart we have measured Gamuda Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Gamuda Berhad.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Gamuda Berhad. To be more specific, the ROCE was 5.0% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Gamuda Berhad to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 31%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.5%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line On Gamuda Berhad's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 16% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know about the risks facing Gamuda Berhad, we've discovered 2 warning signs that you should be aware of.

While Gamuda 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.

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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.