Capital Allocation Trends At Elsoft Research Berhad (KLSE:ELSOFT) Aren't Ideal

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Elsoft Research Berhad (KLSE:ELSOFT), the trends above didn't look too great.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Elsoft Research Berhad is:

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

0.09 = RM10m ÷ (RM122m - RM8.0m) (Based on the trailing twelve months to March 2022).

Thus, Elsoft Research Berhad has an ROCE of 9.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 16%.

See our latest analysis for Elsoft Research Berhad

In the above chart we have measured Elsoft Research Berhad's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

In terms of Elsoft Research Berhad's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 27% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Elsoft Research Berhad becoming one if things continue as they have.

What We Can Learn From Elsoft Research Berhad's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 35% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing, we've spotted 2 warning signs facing Elsoft Research Berhad that you might find interesting.

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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.