Investors Could Be Concerned With PETRONAS Dagangan Berhad's (KLSE:PETDAG) Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, PETRONAS Dagangan Berhad (KLSE:PETDAG) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

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 PETRONAS Dagangan Berhad:

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

0.17 = RM1.0b ÷ (RM20b - RM14b) (Based on the trailing twelve months to September 2022).

So, PETRONAS Dagangan Berhad has an ROCE of 17%. That's a pretty standard return and it's in line with the industry average of 17%.

See our latest analysis for PETRONAS Dagangan Berhad

In the above chart we have measured PETRONAS Dagangan Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for PETRONAS Dagangan Berhad.

How Are Returns Trending?

In terms of PETRONAS Dagangan Berhad's historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 24% that they were earning five years ago. 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 PETRONAS Dagangan Berhad becoming one if things continue as they have.

On a side note, PETRONAS Dagangan Berhad's current liabilities have increased over the last five years to 69% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 17%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On PETRONAS Dagangan Berhad's ROCE

In summary, it's unfortunate that PETRONAS Dagangan Berhad is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 8.8% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you'd like to know more about PETRONAS Dagangan Berhad, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.

While PETRONAS Dagangan 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.