Returns On Capital At China Ecotek (TPE:1535) Paint A Concerning Picture

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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 China Ecotek (TPE:1535), so let's see why.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for China Ecotek:

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

0.013 = NT$43m ÷ (NT$6.0b - NT$2.7b) (Based on the trailing twelve months to September 2020).

Therefore, China Ecotek has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.5%.

See our latest analysis for China Ecotek

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 China Ecotek has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For China Ecotek Tell Us?

We are a bit worried about the trend of returns on capital at China Ecotek. To be more specific, the ROCE was 13% 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. 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 China Ecotek to turn into a multi-bagger.

Another thing to note, China Ecotek has a high ratio of current liabilities to total assets of 44%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On China Ecotek's ROCE

In summary, it's unfortunate that China Ecotek is generating lower returns from the same amount of capital. Long term shareholders who've owned the stock over the last five years have experienced a 30% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

China Ecotek does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

While China Ecotek 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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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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