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. 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. In light of that, when we looked at Kejuruteraanstera Berhad (KLSE:KAB) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Kejuruteraanstera Berhad:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.096 = RM9.5m ÷ (RM178m - RM79m) (Based on the trailing twelve months to March 2021).
So, Kejuruteraanstera Berhad has an ROCE of 9.6%. In absolute terms, that's a low return, but it's much better than the Construction industry average of 6.8%.
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'd like to look at how Kejuruteraanstera Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is Kejuruteraanstera Berhad's ROCE Trending?
In terms of Kejuruteraanstera Berhad's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 43% over the last five years. 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 side note, Kejuruteraanstera Berhad has done well to pay down its current liabilities to 44% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Key Takeaway
To conclude, we've found that Kejuruteraanstera Berhad is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 630% return in the last three years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Kejuruteraanstera Berhad does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those make us uncomfortable...
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
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