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When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. Having said that, after a brief look, Gamuda Berhad (KLSE:GAMUDA) we aren't filled with optimism, but let's investigate further.
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. The formula for this calculation on Gamuda Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = RM462m ÷ (RM20b - RM4.7b) (Based on the trailing twelve months to April 2023).
Therefore, Gamuda Berhad has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Construction industry average of 5.8%.
View our latest analysis for Gamuda Berhad
Above you can see how the current ROCE for Gamuda 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 Gamuda Berhad.
What Can We Tell From Gamuda Berhad's ROCE Trend?
In terms of Gamuda Berhad's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 5.4%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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. If these trends continue, we wouldn't expect Gamuda Berhad to turn into a multi-bagger.
Our Take On Gamuda Berhad'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. Yet despite these concerning fundamentals, the stock has performed strongly with a 68% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.