Are Investors Concerned With What's Going On At L&K Engineering (TPE:6139)?

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after we looked into L&K Engineering (TPE:6139), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for L&K Engineering, this is the formula:

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

0.0038 = NT$52m ÷ (NT$29b - NT$16b) (Based on the trailing twelve months to September 2020).

Thus, L&K Engineering has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Commercial Services industry average of 5.0%.

See our latest analysis for L&K Engineering

In the above chart we have measured L&K Engineering's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for L&K Engineering.

What The Trend Of ROCE Can Tell Us

In terms of L&K Engineering's historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 3.3% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 L&K Engineering to turn into a multi-bagger.

On a separate but related note, it's important to know that L&K Engineering has a current liabilities to total assets ratio of 54%, 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.

Our Take On L&K Engineering's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Since the stock has skyrocketed 124% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with L&K Engineering (including 1 which makes us a bit uncomfortable) .

While L&K Engineering 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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This article by Simply Wall St is general in nature. 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.
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