Returns On Capital At Lungyen Life Service (GTSM:5530) Paint An Interesting Picture

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at Lungyen Life Service (GTSM:5530) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Lungyen Life Service:

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

0.067 = NT$1.3b ÷ (NT$63b - NT$43b) (Based on the trailing twelve months to September 2020).

Thus, Lungyen Life Service has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 10%.

See our latest analysis for Lungyen Life Service

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 Lungyen Life Service has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Lungyen Life Service's ROCE Trending?

On the surface, the trend of ROCE at Lungyen Life Service doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.7% from 17% five years ago. 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 side note, Lungyen Life Service has done well to pay down its current liabilities to 68% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Lungyen Life Service have fallen, meanwhile the business is employing more capital than it was five years ago. Despite the concerning underlying trends, the stock has actually gained 12% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a final note, we've found 1 warning sign for Lungyen Life Service that we think 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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