Be Wary Of CTOS Digital Berhad (KLSE:CTOS) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 CTOS Digital Berhad (KLSE:CTOS), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for CTOS Digital Berhad:

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

0.10 = RM66m ÷ (RM716m - RM63m) (Based on the trailing twelve months to September 2022).

So, CTOS Digital Berhad has an ROCE of 10%. In absolute terms, that's a pretty standard return but compared to the Professional Services industry average it falls behind.

Check out the opportunities and risks within the MY Professional Services industry.

Above you can see how the current ROCE for CTOS Digital 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 CTOS Digital Berhad here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at CTOS Digital Berhad doesn't inspire confidence. Over the last three years, returns on capital have decreased to 10% from 46% three years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, CTOS Digital Berhad has done well to pay down its current liabilities to 8.8% of total assets. So we could link some of this to the decrease in ROCE. 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

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for CTOS Digital Berhad. And there could be an opportunity here if other metrics look good too, because the stock has declined 20% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know about the risks facing CTOS Digital Berhad, we've discovered 1 warning sign that you should be aware of.

While CTOS Digital 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.