Returns On Capital Signal Tricky Times Ahead For Press Metal Aluminium Holdings Berhad (KLSE:PMETAL)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Press Metal Aluminium Holdings Berhad (KLSE:PMETAL), 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 Press Metal Aluminium Holdings Berhad:

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

0.17 = RM2.0b ÷ (RM15b - RM3.5b) (Based on the trailing twelve months to June 2022).

Therefore, Press Metal Aluminium Holdings Berhad has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 13% generated by the Metals and Mining industry.

Our analysis indicates that PMETAL is potentially undervalued!

Above you can see how the current ROCE for Press Metal Aluminium Holdings Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Press Metal Aluminium Holdings Berhad here for free.

What Does the ROCE Trend For Press Metal Aluminium Holdings Berhad Tell Us?

On the surface, the trend of ROCE at Press Metal Aluminium Holdings Berhad doesn't inspire confidence. Over the last five years, returns on capital have decreased to 17% from 22% 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 side note, Press Metal Aluminium Holdings Berhad has done well to pay down its current liabilities to 23% of total assets. So we could link some of this to the decrease in ROCE. 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.

Our Take On Press Metal Aluminium Holdings Berhad's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Press Metal Aluminium Holdings Berhad is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 110% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Press Metal Aluminium Holdings Berhad does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.