Can Action Electronics (TPE:3024) Continue To Grow Its Returns On Capital?

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. With that in mind, we've noticed some promising trends at Action Electronics (TPE:3024) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Action Electronics is:

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

0.0065 = NT$19m ÷ (NT$3.7b - NT$891m) (Based on the trailing twelve months to September 2020).

So, Action Electronics has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 10%.

See our latest analysis for Action Electronics

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

The Trend Of ROCE

We're delighted to see that Action Electronics is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 0.7% on its capital. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

One more thing to note, Action Electronics has decreased current liabilities to 24% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

In Conclusion...

To bring it all together, Action Electronics has done well to increase the returns it's generating from its capital employed. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

On a separate note, we've found 2 warning signs for Action Electronics you'll probably want to know about.

While Action Electronics 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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