Stock Analysis

Should You Be Worried About Gamuda Berhad's (KLSE:GAMUDA) Returns On Capital?

KLSE:GAMUDA
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What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Gamuda Berhad (KLSE:GAMUDA), we weren't too hopeful.

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 Gamuda Berhad is:

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

0.028 = RM357m ÷ (RM19b - RM6.0b) (Based on the trailing twelve months to October 2020).

Thus, Gamuda Berhad has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Construction industry average of 5.2%.

Check out our latest analysis for Gamuda Berhad

roce
KLSE:GAMUDA Return on Capital Employed February 18th 2021

Above you can see how the current ROCE for Gamuda Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Gamuda Berhad here for free.

What Can We Tell From Gamuda Berhad's ROCE Trend?

In terms of Gamuda Berhad's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 4.8% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Gamuda Berhad becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. 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 Key Takeaway

In summary, it's unfortunate that Gamuda Berhad is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Gamuda Berhad does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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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