TES Touch Embedded Solutions (Xiamen) (SZSE:003019) Is Reinvesting At Lower Rates Of Return

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating TES Touch Embedded Solutions (Xiamen) (SZSE:003019), we don't think it's current trends fit the mold of a multi-bagger.

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 TES Touch Embedded Solutions (Xiamen), this is the formula:

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

0.097 = CN¥153m ÷ (CN¥1.9b - CN¥302m) (Based on the trailing twelve months to September 2023).

Therefore, TES Touch Embedded Solutions (Xiamen) has an ROCE of 9.7%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.5%.

Check out our latest analysis for TES Touch Embedded Solutions (Xiamen)

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'd like to look at how TES Touch Embedded Solutions (Xiamen) has performed in the past in other metrics, you can view this free graph of TES Touch Embedded Solutions (Xiamen)'s past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of TES Touch Embedded Solutions (Xiamen)'s historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 33%, but since then they've fallen to 9.7%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, TES Touch Embedded Solutions (Xiamen) has decreased its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for TES Touch Embedded Solutions (Xiamen) have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 18% over the last three years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a final note, we've found 1 warning sign for TES Touch Embedded Solutions (Xiamen) that we think you should be aware of.

While TES Touch Embedded Solutions (Xiamen) may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.