Returns On Capital At Cheng Fwa Industrial (GTSM:5426) Paint A Concerning Picture

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Cheng Fwa Industrial (GTSM:5426), we weren't too upbeat about how things were going.

What is 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. The formula for this calculation on Cheng Fwa Industrial is:

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

0.013 = NT$30m ÷ (NT$2.8b - NT$514m) (Based on the trailing twelve months to September 2020).

So, Cheng Fwa Industrial has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.3%.

See our latest analysis for Cheng Fwa Industrial

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cheng Fwa Industrial's ROCE against it's prior returns. If you'd like to look at how Cheng Fwa Industrial has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Cheng Fwa Industrial's ROCE Trend?

There is reason to be cautious about Cheng Fwa Industrial, given the returns are trending downwards. To be more specific, the ROCE was 4.9% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Cheng Fwa Industrial to turn into a multi-bagger.

What We Can Learn From Cheng Fwa Industrial's ROCE

In summary, it's unfortunate that Cheng Fwa Industrial is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 20% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Cheng Fwa Industrial does come with some risks though, we found 5 warning signs in our investment analysis, and 1 of those can't be ignored...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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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