If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within UMS Holdings Berhad (KLSE:UMS), we weren't too hopeful.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on UMS Holdings Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = RM10m ÷ (RM172m - RM6.3m) (Based on the trailing twelve months to September 2020).
So, UMS Holdings Berhad has an ROCE of 6.3%. In absolute terms, that's a low return but it's around the Trade Distributors industry average of 7.5%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for UMS Holdings Berhad's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of UMS Holdings Berhad, check out these free graphs here.
What Does the ROCE Trend For UMS Holdings Berhad Tell Us?
There is reason to be cautious about UMS Holdings Berhad, given the returns are trending downwards. To be more specific, the ROCE was 9.3% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on UMS Holdings Berhad becoming one if things continue as they have.
The Key Takeaway
All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 17% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for UMS Holdings Berhad (of which 1 shouldn't be ignored!) that you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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