Does Ecoplastic's (KOSDAQ:038110) Returns On Capital Reflect Well On The Business?

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after glancing at the trends within Ecoplastic (KOSDAQ:038110), we weren't too hopeful.

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. The formula for this calculation on Ecoplastic is:

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

0.0012 = ₩217m ÷ (₩617b - ₩436b) (Based on the trailing twelve months to September 2020).

So, Ecoplastic has an ROCE of 0.1%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 4.1%.

View our latest analysis for Ecoplastic

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're interested in investigating Ecoplastic's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We are a bit anxious about the trends of ROCE at Ecoplastic. Unfortunately, returns have declined substantially over the last five years to the 0.1% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 24% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Ecoplastic's current liabilities have increased over the last five years to 71% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 0.1%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

In summary, it's unfortunate that Ecoplastic is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 34% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Ecoplastic (of which 1 doesn't sit too well with us!) that you should know about.

While Ecoplastic 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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