When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Nan Ren Lake Leisure Amusement (GTSM:5905), we weren't too upbeat about how things were going.
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 Nan Ren Lake Leisure Amusement:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.00032 = NT$893k ÷ (NT$3.9b - NT$1.2b) (Based on the trailing twelve months to September 2020).
Therefore, Nan Ren Lake Leisure Amusement has an ROCE of 0.03%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 5.6%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Nan Ren Lake Leisure Amusement's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Nan Ren Lake Leisure Amusement, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Nan Ren Lake Leisure Amusement. About five years ago, returns on capital were 4.5%, however they're now substantially lower than that as we saw above. 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 Nan Ren Lake Leisure Amusement to turn into a multi-bagger.
Our Take On Nan Ren Lake Leisure Amusement's ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 53% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One final note, you should learn about the 4 warning signs we've spotted with Nan Ren Lake Leisure Amusement (including 1 which makes us a bit uncomfortable) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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