Sunway Berhad (KLSE:SUNWAY) Might Be Having Difficulty Using Its Capital Effectively

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Sunway Berhad (KLSE:SUNWAY) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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)

0.024 = RM460m ÷ (RM27b - RM7.3b) (Based on the trailing twelve months to March 2023).

Therefore, Sunway Berhad has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Industrials industry average of 7.2%.

See our latest analysis for Sunway Berhad

In the above chart we have measured Sunway Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sunway Berhad here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sunway Berhad doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.4% from 3.4% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Sunway Berhad has decreased its current liabilities to 28% 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Sunway 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 39% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you'd like to know more about Sunway Berhad, we've spotted 3 warning signs, and 1 of them can't be ignored.

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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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.