Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, China Ecotek (TPE:1535) we aren't filled with optimism, but let's investigate further.
Understanding 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. To calculate this metric for China Ecotek, this is the formula:
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).
Thus, China Ecotek has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Construction industry average of 7.5%.
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're interested in investigating China Ecotek's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
There is reason to be cautious about China Ecotek, given the returns are trending downwards. About five years ago, returns on capital were 13%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Ecotek becoming one if things continue as they have.On a separate but related note, it's important to know that China Ecotek has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In summary, it's unfortunate that China Ecotek is generating lower returns from the same amount of capital. It should come as no surprise then that the stock has fallen 29% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you'd like to know more about China Ecotek, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.
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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