Investors Could Be Concerned With GFM Services Berhad's (KLSE:GFM) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Having said that, from a first glance at GFM Services Berhad (KLSE:GFM) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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 GFM Services Berhad is:

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

0.088 = RM40m ÷ (RM517m - RM59m) (Based on the trailing twelve months to March 2021).

Therefore, GFM Services Berhad has an ROCE of 8.8%. On its own that's a low return, but compared to the average of 4.2% generated by the Commercial Services industry, it's much better.

View our latest analysis for GFM Services Berhad

Historical performance is a great place to start when researching a stock so above you can see the gauge for GFM Services Berhad's ROCE against it's prior returns. 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

On the surface, the trend of ROCE at GFM Services Berhad doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 8.8%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, GFM Services Berhad has decreased its current liabilities to 11% 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 Key Takeaway

In summary, GFM Services Berhad is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 59% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One final note, you should learn about the 6 warning signs we've spotted with GFM Services Berhad (including 2 which are significant) .

While GFM Services 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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