Goodway Machine's (TPE:1583) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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 the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into Goodway Machine (TPE:1583), we weren't too upbeat about how things were going.

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. Analysts use this formula to calculate it for Goodway Machine:

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

0.0084 = NT$58m ÷ (NT$12b - NT$5.3b) (Based on the trailing twelve months to December 2020).

So, Goodway Machine has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.5%.

See our latest analysis for Goodway Machine

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 Goodway Machine 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 Goodway Machine's ROCE Trend?

We are a bit worried about the trend of returns on capital at Goodway Machine. About five years ago, returns on capital were 12%, 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. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Goodway Machine becoming one if things continue as they have.

On a separate but related note, it's important to know that Goodway Machine has a current liabilities to total assets ratio of 43%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Goodway Machine's ROCE

In summary, it's unfortunate that Goodway Machine is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 25% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a separate note, we've found 3 warning signs for Goodway Machine you'll probably want to know about.

While Goodway Machine 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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