ATA IMS Berhad (KLSE:ATAIMS) Could Be Struggling To Allocate Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after investigating ATA IMS Berhad (KLSE:ATAIMS), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for ATA IMS Berhad, this is the formula:

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

0.074 = RM70m ÷ (RM1.8b - RM904m) (Based on the trailing twelve months to December 2021).

So, ATA IMS Berhad has an ROCE of 7.4%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 14%.

View our latest analysis for ATA IMS Berhad

Above you can see how the current ROCE for ATA IMS Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering ATA IMS Berhad here for free.

What Does the ROCE Trend For ATA IMS Berhad Tell Us?

In terms of ATA IMS Berhad's historical ROCE movements, the trend isn't fantastic. Over the last four years, returns on capital have decreased to 7.4% from 31% four years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, ATA IMS Berhad has decreased its current liabilities to 49% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 49% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

In summary, we're somewhat concerned by ATA IMS Berhad's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 68% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One more thing: We've identified 4 warning signs with ATA IMS Berhad (at least 1 which is significant) , and understanding these would certainly be useful.

While ATA IMS 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.

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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.