Should You Be Worried About Koan Hao Technology's (GTSM:8354) Returns On Capital?

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. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Koan Hao Technology (GTSM:8354), we weren't too upbeat about how things were going.

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 Koan Hao Technology is:

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

0.029 = NT$68m ÷ (NT$3.4b - NT$1.1b) (Based on the trailing twelve months to September 2020).

Thus, Koan Hao Technology has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 5.0%.

View our latest analysis for Koan Hao Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Koan Hao Technology's ROCE against it's prior returns. If you're interested in investigating Koan Hao Technology's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

There is reason to be cautious about Koan Hao Technology, given the returns are trending downwards. About five years ago, returns on capital were 3.9%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Koan Hao Technology to turn into a multi-bagger.

On a side note, Koan Hao Technology's current liabilities have increased over the last five years to 31% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. However the stock has delivered a 60% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Koan Hao Technology we've found 5 warning signs (1 is significant!) that you should be aware of before investing here.

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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