GFM Services Berhad (KLSE:GFM) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think GFM Services Berhad (KLSE:GFM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on GFM Services Berhad is:

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

0.089 = RM41m ÷ (RM517m - RM62m) (Based on the trailing twelve months to September 2021).

Therefore, GFM Services Berhad has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 5.9% generated by the Commercial Services industry, it's much better.

Check out our latest analysis for GFM Services Berhad

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how GFM Services Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of GFM Services Berhad's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 25% over the last five years. 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 related note, GFM Services Berhad has decreased its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that GFM Services Berhad is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 51% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

GFM Services Berhad does come with some risks though, we found 5 warning signs in our investment analysis, and 2 of those are significant...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.