If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. In light of that, when we looked at Union Community (KOSDAQ:203450) and its ROCE trend, we weren't exactly thrilled.
What is 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. To calculate this metric for Union Community, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = ₩2.3b ÷ (₩57b - ₩17b) (Based on the trailing twelve months to September 2020).
Therefore, Union Community has an ROCE of 5.9%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.6%.
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 Union Community's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Union Community Tell Us?
When we looked at the ROCE trend at Union Community, we didn't gain much confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 5.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Union Community has done well to pay down its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In summary, despite lower returns in the short term, we're encouraged to see that Union Community is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 47% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.
On a separate note, we've found 5 warning signs for Union Community you'll probably want to know about.
While Union Community isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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