Here's What's Concerning About Greatech Technology Berhad's (KLSE:GREATEC) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. In light of that, when we looked at Greatech Technology Berhad (KLSE:GREATEC) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. To calculate this metric for Greatech Technology Berhad, this is the formula:

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

0.19 = RM104m ÷ (RM726m - RM171m) (Based on the trailing twelve months to September 2022).

So, Greatech Technology Berhad has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 15% it's much better.

Our analysis indicates that GREATEC is potentially overvalued!

Above you can see how the current ROCE for Greatech Technology Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. 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 Greatech Technology Berhad's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 19% from 40% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Greatech Technology Berhad has done well to pay down its current liabilities to 24% 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 Greatech Technology Berhad's ROCE

While returns have fallen for Greatech Technology Berhad in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 347% to shareholders in the last three years. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing to note, we've identified 1 warning sign with Greatech Technology Berhad and understanding this should be part of your investment process.

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.