Investors Could Be Concerned With Pestech International Berhad's (KLSE:PESTECH) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Pestech International Berhad (KLSE:PESTECH), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Pestech International Berhad, this is the formula:

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

0.013 = RM23m ÷ (RM3.1b - RM1.4b) (Based on the trailing twelve months to September 2022).

Thus, Pestech International Berhad has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 5.3%.

See our latest analysis for Pestech International Berhad

In the above chart we have measured Pestech International Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Pestech International Berhad's ROCE Trend?

When we looked at the ROCE trend at Pestech International Berhad, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.3% from 14% five years ago. 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 separate but related note, it's important to know that Pestech International Berhad has a current liabilities to total assets ratio of 45%, 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.

The Key Takeaway

In summary, we're somewhat concerned by Pestech International Berhad's diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 78% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Pestech International Berhad (of which 2 are a bit unpleasant!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.