Some Investors May Be Worried About Mestron Holdings Berhad's (KLSE:MESTRON) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Although, when we looked at Mestron Holdings Berhad (KLSE:MESTRON), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Mestron Holdings Berhad:

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

0.06 = RM7.3m ÷ (RM143m - RM20m) (Based on the trailing twelve months to September 2022).

Thus, Mestron Holdings Berhad has an ROCE of 6.0%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 11%.

See our latest analysis for Mestron Holdings Berhad

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Mestron Holdings Berhad doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.0% from 26% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Mestron Holdings Berhad has decreased its current liabilities to 14% 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. 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, despite lower returns in the short term, we're encouraged to see that Mestron Holdings Berhad is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 288% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Like most companies, Mestron Holdings Berhad does come with some risks, and we've found 2 warning signs that you should be aware of.

While Mestron Holdings 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.