Microlink Solutions Berhad (KLSE:MICROLN) Knows How To Allocate Capital Effectively

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Microlink Solutions Berhad's (KLSE:MICROLN) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

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 Microlink Solutions Berhad, this is the formula:

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

0.35 = RM18m ÷ (RM149m - RM97m) (Based on the trailing twelve months to September 2020).

Therefore, Microlink Solutions Berhad has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Software industry average of 10%.

View our latest analysis for Microlink Solutions Berhad

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

So How Is Microlink Solutions Berhad's ROCE Trending?

You'd find it hard not to be impressed with the ROCE trend at Microlink Solutions Berhad. We found that the returns on capital employed over the last five years have risen by 144%. The company is now earning RM0.3 per dollar of capital employed. Interestingly, the business may be becoming more efficient because it's applying 45% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 66% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Key Takeaway

From what we've seen above, Microlink Solutions Berhad has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has only returned 36% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Microlink Solutions Berhad does have some risks though, and we've spotted 2 warning signs for Microlink Solutions Berhad that you might be interested in.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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