What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 MGB Berhad (KLSE:MGB) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. To calculate this metric for MGB Berhad, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = RM25m ÷ (RM958m - RM444m) (Based on the trailing twelve months to December 2020).
Therefore, MGB Berhad has an ROCE of 4.9%. Even though it's in line with the industry average of 4.8%, it's still a low return by itself.
See our latest analysis for MGB Berhad
Above you can see how the current ROCE for MGB Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
When we looked at the ROCE trend at MGB Berhad, we didn't gain much confidence. To be more specific, ROCE has fallen from 33% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a side note, MGB Berhad has done well to pay down its current liabilities to 46% 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. Keep in mind 46% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line On MGB Berhad's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for MGB Berhad have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last three years have experienced a 22% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Like most companies, MGB Berhad does come with some risks, and we've found 1 warning sign that you should be aware of.
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. 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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About KLSE:MGB
MGB Berhad
An investment holding company, operates as a construction and development company in Malaysia.
Very undervalued with flawless balance sheet.
