Euro Holdings Berhad (KLSE:EURO) Is Finding It Tricky To Allocate Its Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Euro Holdings Berhad (KLSE:EURO), we weren't too upbeat about how things were going.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Euro Holdings Berhad:

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

0.0057 = RM440k ÷ (RM129m - RM52m) (Based on the trailing twelve months to March 2021).

So, Euro Holdings Berhad has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 4.2%.

View our latest analysis for Euro Holdings Berhad

Historical performance is a great place to start when researching a stock so above you can see the gauge for Euro Holdings Berhad's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Euro Holdings Berhad, check out these free graphs here.

So How Is Euro Holdings Berhad's ROCE Trending?

There is reason to be cautious about Euro Holdings Berhad, given the returns are trending downwards. About five years ago, returns on capital were 5.3%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect Euro Holdings Berhad to turn into a multi-bagger.

On a side note, Euro Holdings Berhad's current liabilities are still rather high at 40% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these poor fundamentals, the stock has gained a huge 1,433% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

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

While Euro Holdings Berhad may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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