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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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Muhibbah Engineering (M) Bhd (KLSE:MUHIBAH) and its ROCE trend, we weren't exactly thrilled.

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Muhibbah Engineering (M) Bhd is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) (Total Assets - Current Liabilities)

0.019 = RM40m (RM3.4b - RM1.2b) (Based on the trailing twelve months to September 2023).

Therefore, Muhibbah Engineering (M) Bhd has an ROCE of 1.9%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.3%.

Check out our latest analysis for Muhibbah Engineering (M) Bhd

roce

In the above chart we have measured Muhibbah Engineering (M) Bhd's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

On the surface, the trend of ROCE at Muhibbah Engineering (M) Bhd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.9% from 4.8% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

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On a related note, Muhibbah Engineering (M) Bhd has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

While returns have fallen for Muhibbah Engineering (M) Bhd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 69% over the last five years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

While Muhibbah Engineering (M) Bhd doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Muhibbah Engineering (M) Bhd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Excerpt from:

Muhibbah Engineering (M) Bhd (KLSE:MUHIBAH) May Have Issues Allocating Its Capital - Yahoo Finance