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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at INVENIA (KOSDAQ:079950), it didn't seem to tick all of these boxes.
Understanding 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. To calculate this metric for INVENIA, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.035 = ₩1.9b ÷ (₩139b - ₩86b) (Based on the trailing twelve months to September 2020).
Therefore, INVENIA has an ROCE of 3.5%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 9.8%.
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'd like to look at how INVENIA has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
When we looked at the ROCE trend at INVENIA, we didn't gain much confidence. Around five years ago the returns on capital were 5.7%, but since then they've fallen to 3.5%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 62%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.5%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.
The Bottom Line
We're a bit apprehensive about INVENIA because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 51% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing: We've identified 3 warning signs with INVENIA (at least 2 which are significant) , and understanding these would certainly be useful.
While INVENIA 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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