Be Wary Of Lotte Chemical (KRX:011170) And Its Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Lotte Chemical ( KRX:011170 ) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

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 Lotte Chemical is:

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

0.022 = ₩357b ÷ (₩19t - ₩2.9t) (Based on the trailing twelve months to December 2020) .

Thus, Lotte Chemical has an ROCE of 2.2%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 7.9%. However, we also note that in the previous year, the company had a series of one-off expenses which has reduced the ROCE below what it normally is.

View our latest analysis for Lotte Chemical

In the above chart we have measured Lotte Chemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lotte Chemical here for free.

How Are Returns Trending?

When we looked at the ROCE trend at Lotte Chemical, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.2% from 17% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

Our Take On Lotte Chemical's ROCE

We're a bit apprehensive about Lotte Chemical because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 1.4% 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.

One more thing to note, we've identified 2 warning signs with Lotte Chemical and understanding these should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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