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. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at HG Metal Manufacturing (SGX:BTG) and its trend of ROCE, we really liked what we saw.

What Is 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. The formula for this calculation on HG Metal Manufacturing is:

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

0.039 = S$4.7m ÷ (S$158m - S$37m) (Based on the trailing twelve months to December 2022).

Thus, HG Metal Manufacturing has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 8.0%.

See our latest analysis for HG Metal Manufacturing

Historical performance is a great place to start when researching a stock so above you can see the gauge for HG Metal Manufacturing's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of HG Metal Manufacturing, check out these free graphs here.

What Does the ROCE Trend For HG Metal Manufacturing Tell Us?

We're delighted to see that HG Metal Manufacturing is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 3.9% on its capital. While returns have increased, the amount of capital employed by HG Metal Manufacturing has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 23% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

To bring it all together, HG Metal Manufacturing has done well to increase the returns it's generating from its capital employed. Considering the stock has delivered 33% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

HG Metal Manufacturing does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...

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.

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.

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