Khong Guan (SGX:K03) May Have Issues Allocating Its Capital

What financial metrics can indicate to us that a company is maturing or even in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. So after glancing at the trends within Khong Guan (SGX:K03), we weren't too hopeful.

Understanding 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. The formula for this calculation on Khong Guan is:

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

0.028 = S$1.8m ÷ (S$71m - S$6.2m) (Based on the trailing twelve months to January 2021).

So, Khong Guan has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Consumer Retailing industry average of 7.0%.

View our latest analysis for Khong Guan

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Khong Guan has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Khong Guan's ROCE Trending?

We are a bit worried about the trend of returns on capital at Khong Guan. About five years ago, returns on capital were 8.0%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Khong Guan becoming one if things continue as they have.

Our Take On Khong Guan's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Long term shareholders who've owned the stock over the last five years have experienced a 20% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to know some of the risks facing Khong Guan we've found 2 warning signs (1 can't be ignored!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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