Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Stella Holdings Berhad (KLSE:STELLA), 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. Analysts use this formula to calculate it for Stella Holdings Berhad:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.093 = RM4.7m ÷ (RM73m - RM22m) (Based on the trailing twelve months to December 2020).
Thus, Stella Holdings Berhad has an ROCE of 9.3%. In absolute terms, that's a low return, but it's much better than the Construction industry average of 4.9%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Stella Holdings Berhad's ROCE against it's prior returns. If you'd like to look at how Stella Holdings Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Stella Holdings Berhad's ROCE Trend?
We're a bit concerned with the trends, because the business is applying 20% less capital than it was five years ago and returns on that capital have stayed flat. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. In addition to that, since the ROCE doesn't scream "quality" at 9.3%, it's hard to get excited about these developments.
On a side note, Stella Holdings Berhad has done well to reduce current liabilities to 30% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
It's a shame to see that Stella Holdings Berhad is effectively shrinking in terms of its capital base. Yet to long term shareholders the stock has gifted them an incredible 124% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One final note, you should learn about the 3 warning signs we've spotted with Stella Holdings Berhad (including 1 which is potentially serious) .
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.
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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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