The Returns On Capital At SDS Group Berhad (KLSE:SDS) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Although, when we looked at SDS Group Berhad (KLSE:SDS), it didn't seem to tick all of these boxes.

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 SDS Group Berhad is:

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

0.084 = RM9.2m ÷ (RM144m - RM35m) (Based on the trailing twelve months to December 2020).

Therefore, SDS Group Berhad has an ROCE of 8.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.6%.

See our latest analysis for SDS Group Berhad

In the above chart we have measured SDS Group Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering SDS Group Berhad here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at SDS Group Berhad doesn't inspire confidence. Over the last four years, returns on capital have decreased to 8.4% from 11% four years ago. However it looks like SDS Group Berhad might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, SDS Group Berhad has decreased its current liabilities to 24% 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. 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

To conclude, we've found that SDS Group Berhad is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 174% return in the last year, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing SDS Group Berhad, we've discovered 2 warning signs that you should be aware of.

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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