Returns On Capital Signal Difficult Times Ahead For Tek Seng Holdings Berhad (KLSE:TEKSENG)

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Tek Seng Holdings Berhad (KLSE:TEKSENG), we weren't too hopeful.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Tek Seng Holdings Berhad:

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

0.13 = RM36m ÷ (RM311m - RM29m) (Based on the trailing twelve months to March 2021).

Thus, Tek Seng Holdings Berhad has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 8.0% it's much better.

Check out our latest analysis for Tek Seng Holdings Berhad

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tek Seng Holdings Berhad's ROCE against it's prior returns. If you'd like to look at how Tek Seng Holdings Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Tek Seng Holdings Berhad's ROCE Trend?

In terms of Tek Seng Holdings Berhad's historical ROCE trend, it isn't fantastic. The company used to generate 20% on its capital five years ago but it has since fallen noticeably. What's equally concerning is that the amount of capital deployed in the business has shrunk by 30% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

The Key Takeaway

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. It should come as no surprise then that the stock has fallen 47% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you want to know some of the risks facing Tek Seng Holdings Berhad we've found 4 warning signs (1 is significant!) that you should be aware of before investing here.

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. 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.
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