If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Sunway Berhad (KLSE:SUNWAY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Sunway Berhad:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0088 = RM111m ÷ (RM21b - RM8.1b) (Based on the trailing twelve months to March 2021).
So, Sunway Berhad has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs the Industrials industry average of 7.9%.
Above you can see how the current ROCE for Sunway Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Sunway Berhad here for free.
So How Is Sunway Berhad's ROCE Trending?
When we looked at the ROCE trend at Sunway Berhad, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 0.9% from 5.7% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
Our Take On Sunway Berhad's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Sunway Berhad have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 62% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Sunway Berhad (of which 1 doesn't sit too well with us!) that you should know about.
While Sunway Berhad isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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