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. So, when we ran our eye over WFE Technology's (GTSM:6474) trend of ROCE, we liked what we saw.
What is 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. The formula for this calculation on WFE Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = NT$142m ÷ (NT$2.7b - NT$1.5b) (Based on the trailing twelve months to June 2020).
Therefore, WFE Technology has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 7.1% generated by the Electrical industry.
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 WFE Technology 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?
While the returns on capital are good, they haven't moved much. The company has employed 79% more capital in the last five years, and the returns on that capital have remained stable at 13%. 13% is a pretty standard return, and it provides some comfort knowing that WFE Technology has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
On a separate but related note, it's important to know that WFE Technology has a current liabilities to total assets ratio of 58%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From WFE Technology's ROCE
To sum it up, WFE Technology has simply been reinvesting capital steadily, at those decent rates of return. Yet over the last three years the stock has declined 13%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.
One final note, you should learn about the 4 warning signs we've spotted with WFE Technology (including 1 which can't be ignored) .
While WFE Technology 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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