What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. So when we looked at TAFI Industries Berhad (KLSE:TAFI) and its trend of ROCE, we really liked what we saw.
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 TAFI Industries Berhad is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = RM11m ÷ (RM137m - RM57m) (Based on the trailing twelve months to June 2023).
Thus, TAFI Industries Berhad has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 8.1% generated by the Commercial Services industry.
View our latest analysis for TAFI Industries Berhad
Historical performance is a great place to start when researching a stock so above you can see the gauge for TAFI Industries Berhad's ROCE against it's prior returns. If you'd like to look at how TAFI Industries Berhad has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
The fact that TAFI Industries Berhad is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 13% on its capital. Not only that, but the company is utilizing 66% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 42% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.