Rechi Precision (TPE:4532) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Rechi Precision (TPE:4532) and its ROCE trend, we weren't exactly thrilled.

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 Rechi Precision is:

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

0.052 = NT$799m ÷ (NT$27b - NT$12b) (Based on the trailing twelve months to September 2020).

So, Rechi Precision has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Machinery industry average of 9.4%.

See our latest analysis for Rechi Precision

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

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Rechi Precision, we didn't gain much confidence. To be more specific, ROCE has fallen from 10% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

Another thing to note, Rechi Precision has a high ratio of current liabilities to total assets of 43%. 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.

Our Take On Rechi Precision's ROCE

In summary, we're somewhat concerned by Rechi Precision's diminishing returns on increasing amounts of capital. In spite of that, the stock has delivered a 5.1% return to shareholders who held over 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Rechi Precision (of which 1 makes us a bit uncomfortable!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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