Returns On Capital Signal Tricky Times Ahead For Lungyen Life Service (GTSM:5530)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Lungyen Life Service (GTSM:5530), we don't think it's current trends fit the mold of a multi-bagger.

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

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. 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)

0.062 = NT$1.3b ÷ (NT$64b - NT$43b) (Based on the trailing twelve months to December 2020).

Therefore, Lungyen Life Service has an ROCE of 6.2%. On its own, that's a low figure but it's around the 7.1% average generated by the Consumer Services industry.

See our latest analysis for Lungyen Life Service

Historical performance is a great place to start when researching a stock so above you can see the gauge for Lungyen Life Service's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Lungyen Life Service, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Lungyen Life Service doesn't inspire confidence. Around five years ago the returns on capital were 13%, but since then they've fallen to 6.2%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Lungyen Life Service has decreased its current liabilities to 68% 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. 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. Keep in mind 68% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

In summary, we're somewhat concerned by Lungyen Life Service's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 15% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing, we've spotted 2 warning signs facing Lungyen Life Service that you might find interesting.

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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