Some Investors May Be Worried About Cathay Consolidated's (TPE:1342) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Cathay Consolidated (TPE:1342), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Cathay Consolidated is:

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

0.15 = NT$250m ÷ (NT$2.0b - NT$297m) (Based on the trailing twelve months to December 2020).

Therefore, Cathay Consolidated has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 2.8% generated by the Luxury industry.

See our latest analysis for Cathay Consolidated

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 Cathay Consolidated 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

On the surface, the trend of ROCE at Cathay Consolidated doesn't inspire confidence. Around four years ago the returns on capital were 19%, but since then they've fallen to 15%. However it looks like Cathay Consolidated might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Cathay Consolidated has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. 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 Bottom Line On Cathay Consolidated's ROCE

Bringing it all together, while we're somewhat encouraged by Cathay Consolidated's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 32% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Like most companies, Cathay Consolidated does come with some risks, and we've found 2 warning signs that you should be aware of.

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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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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