Some Investors May Be Worried About Nestcon Berhad's (KLSE:NESTCON) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Nestcon Berhad (KLSE:NESTCON), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 Nestcon Berhad:

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

0.083 = RM16m ÷ (RM468m - RM274m) (Based on the trailing twelve months to September 2022).

Therefore, Nestcon Berhad has an ROCE of 8.3%. In absolute terms, that's a low return, but it's much better than the Construction industry average of 5.3%.

See our latest analysis for Nestcon Berhad

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 Nestcon Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Nestcon Berhad doesn't inspire confidence. Around four years ago the returns on capital were 18%, but since then they've fallen to 8.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Nestcon Berhad has a current liabilities to total assets ratio of 59%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Nestcon Berhad is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 4.4% gain to shareholders who've held over the last year. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One final note, you should learn about the 4 warning signs we've spotted with Nestcon Berhad (including 1 which is a bit unpleasant) .

While Nestcon Berhad may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.