There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. So on that note, Melati Ehsan Holdings Berhad (KLSE:MELATI) looks quite promising in regards to its trends of return on capital.
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. To calculate this metric for Melati Ehsan Holdings Berhad, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.04 = RM8.5m ÷ (RM377m - RM163m) (Based on the trailing twelve months to February 2021).
Therefore, Melati Ehsan Holdings Berhad has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Construction industry average of 5.9%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Melati Ehsan Holdings Berhad's ROCE against it's prior returns. If you'd like to look at how Melati Ehsan Holdings 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 Melati Ehsan Holdings Berhad's ROCE Trending?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The figures show that over the last five years, ROCE has grown 36% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
Our Take On Melati Ehsan Holdings Berhad's ROCE
To sum it up, Melati Ehsan Holdings Berhad is collecting higher returns from the same amount of capital, and that's impressive. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.
Melati Ehsan Holdings Berhad does have some risks, we noticed 6 warning signs (and 2 which don't sit too well with us) we think you should know about.
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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