When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. More often than not, we'll see a declining return on capital employed (ROCE) and a declining 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. Having said that, after a brief look, Gadang Holdings Berhad (KLSE:GADANG) we aren't filled with optimism, but let's investigate further.
What Is 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 Gadang Holdings Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.068 = RM80m ÷ (RM1.6b - RM373m) (Based on the trailing twelve months to August 2022).
Thus, Gadang Holdings Berhad has an ROCE of 6.8%. On its own that's a low return, but compared to the average of 5.4% generated by the Construction industry, it's much better.
Above you can see how the current ROCE for Gadang Holdings 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 Gadang Holdings Berhad here for free.
How Are Returns Trending?
There is reason to be cautious about Gadang Holdings Berhad, given the returns are trending downwards. About five years ago, returns on capital were 13%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Gadang Holdings Berhad becoming one if things continue as they have.
What We Can Learn From Gadang Holdings Berhad's ROCE
In summary, it's unfortunate that Gadang Holdings Berhad is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 66% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing: We've identified 3 warning signs with Gadang Holdings Berhad (at least 1 which can't be ignored) , and understanding them would certainly be useful.
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.
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