Be Wary Of Advanced Energy Solution Holding (TWSE:6781) And Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Advanced Energy Solution Holding (TWSE:6781) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Advanced Energy Solution Holding is:

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

0.15 = NT$2.0b ÷ (NT$20b - NT$6.1b) (Based on the trailing twelve months to June 2024).

So, Advanced Energy Solution Holding has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 7.9% generated by the Electrical industry.

See our latest analysis for Advanced Energy Solution Holding

Above you can see how the current ROCE for Advanced Energy Solution Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Advanced Energy Solution Holding .

What The Trend Of ROCE Can Tell Us

In terms of Advanced Energy Solution Holding's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 24% 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.

On a related note, Advanced Energy Solution Holding has decreased its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

In summary, we're somewhat concerned by Advanced Energy Solution Holding's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 56% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Advanced Energy Solution Holding (of which 1 makes us a bit uncomfortable!) that you should know about.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.