Be Wary Of STO (KOSDAQ:098660) And Its Returns On Capital

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into STO (KOSDAQ:098660), the trends above didn't look too great.

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. Analysts use this formula to calculate it for STO:

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

0.044 = ₩2.0b ÷ (₩74b - ₩30b) (Based on the trailing twelve months to September 2020).

Thus, STO has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 7.4%.

Check out our latest analysis for STO

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 STO's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is STO's ROCE Trending?

In terms of STO's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on STO becoming one if things continue as they have.

On a separate but related note, it's important to know that STO has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, it's unfortunate that STO is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 11% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about STO, we've spotted 6 warning signs, and 2 of them are significant.

While STO 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. 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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