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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Although, when we looked at Perdana Petroleum Berhad (KLSE:PERDANA), it didn't seem to tick all of these boxes.
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. To calculate this metric for Perdana Petroleum Berhad, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = RM53m ÷ (RM902m - RM110m) (Based on the trailing twelve months to September 2023).
So, Perdana Petroleum Berhad has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Energy Services industry average of 9.2%.
Check out our latest analysis for Perdana Petroleum Berhad
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Perdana Petroleum Berhad's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Perdana Petroleum Berhad doesn't inspire confidence. To be more specific, ROCE has fallen from 11% 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. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Perdana Petroleum Berhad has done well to pay down its current liabilities to 12% of total assets. Since the ratio used to be 62%, that's a significant reduction and it no doubt explains the drop in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.