OptoelectronicsLtd (TYO:6664) Will Be Hoping To Turn Its Returns On Capital Around

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. And from a first read, things don't look too good at OptoelectronicsLtd (TYO:6664), so let's see why.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on OptoelectronicsLtd is:

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

0.024 = JP¥228m ÷ (JP¥14b - JP¥4.6b) (Based on the trailing twelve months to February 2021).

So, OptoelectronicsLtd has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 7.2%.

See our latest analysis for OptoelectronicsLtd

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

What The Trend Of ROCE Can Tell Us

There is reason to be cautious about OptoelectronicsLtd, given the returns are trending downwards. About five years ago, returns on capital were 5.8%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect OptoelectronicsLtd to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that OptoelectronicsLtd is generating lower returns from the same amount of capital. In spite of that, the stock has delivered a 31% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you want to know some of the risks facing OptoelectronicsLtd we've found 3 warning signs (1 can't be ignored!) that you should be aware of before investing here.

While OptoelectronicsLtd 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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