If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Kim Heng (Catalist:5G2) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Kim Heng, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = S$8.8m ÷ (S$149m - S$56m) (Based on the trailing twelve months to June 2023).
So, Kim Heng has an ROCE of 9.5%. In absolute terms, that's a low return, but it's much better than the Energy Services industry average of 6.0%.
Check out our latest analysis for Kim Heng
Historical performance is a great place to start when researching a stock so above you can see the gauge for Kim Heng's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Kim Heng, check out these free graphs here.
So How Is Kim Heng's ROCE Trending?
Shareholders will be relieved that Kim Heng has broken into profitability. The company now earns 9.5% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
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 38% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.