If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Topower's (GTSM:3226) returns on capital, so let's have a 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 Topower is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.33 = NT$448m ÷ (NT$2.2b - NT$857m) (Based on the trailing twelve months to December 2020).
Thus, Topower has an ROCE of 33%. In absolute terms that's a great return and it's even better than the Electrical industry average of 7.6%.
Check out our latest analysis for Topower
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 want to delve into the historical earnings, revenue and cash flow of Topower, check out these free graphs here.
The Trend Of ROCE
Investors would be pleased with what's happening at Topower. Over the last five years, returns on capital employed have risen substantially to 33%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 51%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 39% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From Topower's ROCE
All in all, it's terrific to see that Topower is reaping the rewards from prior investments and is growing its capital base. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 24% to shareholders. So with that in mind, we think the stock deserves further research.
Topower does have some risks though, and we've spotted 1 warning sign for Topower that you might be interested in.
Topower is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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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About TPEX:3226
LFA
Manufactures and sells automotive components, electronic components, and power supplies in Taiwan.
Solid track record with excellent balance sheet.