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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Southern Steel Berhad (KLSE:SSTEEL) and its trend of ROCE, we really liked what we saw.
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 Southern Steel Berhad:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.014 = RM16m ÷ (RM2.2b - RM1.1b) (Based on the trailing twelve months to March 2021).
So, Southern Steel Berhad has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 12%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Southern Steel Berhad's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
Southern Steel Berhad has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 1.4% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Southern Steel Berhad has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
On a side note, Southern Steel Berhad's current liabilities are still rather high at 49% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
In summary, we're delighted to see that Southern Steel Berhad has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.
If you'd like to know about the risks facing Southern Steel Berhad, we've discovered 1 warning sign that you should be aware of.
While Southern Steel 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.
When trading stocks or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.