Returns Are Gaining Momentum At Megachem (Catalist:5DS)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Megachem's (Catalist:5DS) returns on capital, so let's have a look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Megachem, this is the formula:

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

0.11 = S$7.1m ÷ (S$117m - S$52m) (Based on the trailing twelve months to December 2022).

So, Megachem has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Trade Distributors industry average of 9.5%.

See our latest analysis for Megachem

Historical performance is a great place to start when researching a stock so above you can see the gauge for Megachem's ROCE against it's prior returns. If you're interested in investigating Megachem's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Megachem's ROCE Trend?

The trends we've noticed at Megachem are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 32%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that Megachem has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Megachem's ROCE

All in all, it's terrific to see that Megachem is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a solid 92% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

Megachem does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.