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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at IBO Technology (HKG:2708) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on IBO Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0074 = CN¥3.1m ÷ (CN¥705m - CN¥289m) (Based on the trailing twelve months to September 2020).
So, IBO Technology has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Electronic industry average of 7.7%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for IBO Technology's ROCE against it's prior returns. If you'd like to look at how IBO Technology has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
When we looked at the ROCE trend at IBO Technology, we didn't gain much confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 0.7%. 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.On a side note, IBO Technology has done well to pay down its current liabilities to 41% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
What We Can Learn From IBO Technology's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for IBO Technology. And the stock has followed suit returning a meaningful 55% to shareholders over the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for IBO Technology (of which 2 are a bit concerning!) that you should know about.
While IBO Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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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