Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at UWC Berhad (KLSE:UWC) and its ROCE trend, we weren't exactly thrilled.
What Is 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. The formula for this calculation on UWC Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = RM68m ÷ (RM464m - RM28m) (Based on the trailing twelve months to July 2023).
Thus, UWC Berhad has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Machinery industry.
Above you can see how the current ROCE for UWC Berhad compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for UWC Berhad.
How Are Returns Trending?
In terms of UWC Berhad's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 30%, but since then they've fallen to 16%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, UWC Berhad has decreased its current liabilities to 6.0% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From UWC Berhad's ROCE
We're a bit apprehensive about UWC Berhad because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last three years have experienced a 12% 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.
UWC Berhad does have some risks though, and we've spotted 1 warning sign for UWC Berhad that you might be interested in.
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.