Sinmag Equipment (GTSM:1580) May Have Issues Allocating Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? 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. And from a first read, things don't look too good at Sinmag Equipment (GTSM:1580), so let's see why.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Sinmag Equipment:

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

0.22 = NT$496m ÷ (NT$3.1b - NT$895m) (Based on the trailing twelve months to September 2020).

So, Sinmag Equipment has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 9.4% earned by companies in a similar industry.

Check out our latest analysis for Sinmag Equipment

Historical performance is a great place to start when researching a stock so above you can see the gauge for Sinmag Equipment's ROCE against it's prior returns. If you'd like to look at how Sinmag Equipment 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?

We are a bit worried about the trend of returns on capital at Sinmag Equipment. Unfortunately the returns on capital have diminished from the 36% that they were earning five years ago. 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. If these trends continue, we wouldn't expect Sinmag Equipment to turn into a multi-bagger.

What We Can Learn From Sinmag Equipment's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. In spite of that, the stock has delivered a 34% 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 final note, you should learn about the 2 warning signs we've spotted with Sinmag Equipment (including 1 which is concerning) .

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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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