If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Hong Leong Industries Berhad (KLSE:HLIND) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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 Hong Leong Industries Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = RM244m ÷ (RM2.4b - RM412m) (Based on the trailing twelve months to September 2020).
Therefore, Hong Leong Industries Berhad has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.3% generated by the Industrials industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Hong Leong Industries Berhad, check out these free graphs here.
So How Is Hong Leong Industries Berhad's ROCE Trending?
On the surface, the trend of ROCE at Hong Leong Industries Berhad doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 12%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line On Hong Leong Industries Berhad's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Hong Leong Industries Berhad have fallen, meanwhile the business is employing more capital than it was five years ago. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 75% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Hong Leong Industries Berhad does have some risks though, and we've spotted 2 warning signs for Hong Leong Industries Berhad that you might be interested in.
While Hong Leong Industries 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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