Stock Analysis

Returns On Capital Signal Tricky Times Ahead For AEM Holdings (SGX:AWX)

SGX:AWX
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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at AEM Holdings (SGX:AWX), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

What Is 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. The formula for this calculation on AEM Holdings is:

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

0.30 = S$172m ÷ (S$829m - S$260m) (Based on the trailing twelve months to June 2022).

Therefore, AEM Holdings has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 24% earned by companies in a similar industry.

See our latest analysis for AEM Holdings

roce
SGX:AWX Return on Capital Employed October 13th 2022

Above you can see how the current ROCE for AEM Holdings 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

On the surface, the trend of ROCE at AEM Holdings doesn't inspire confidence. Historically returns on capital were even higher at 48%, but they have dropped over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, AEM Holdings has decreased its current liabilities to 31% 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.

What We Can Learn From AEM Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for AEM Holdings. And long term investors must be optimistic going forward because the stock has returned a huge 453% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing: We've identified 2 warning signs with AEM Holdings (at least 1 which doesn't sit too well with us) , and understanding them would certainly be useful.

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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Find out whether AEM Holdings is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.