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. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Success Prime (TPE:2496) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Success Prime is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.08 = NT$72m ÷ (NT$1.3b - NT$367m) (Based on the trailing twelve months to December 2020).
Thus, Success Prime has an ROCE of 8.0%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 10%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Success Prime's ROCE against it's prior returns. If you'd like to look at how Success Prime has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
So How Is Success Prime's ROCE Trending?
The fact that Success Prime is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 8.0% on its capital. In addition to that, Success Prime is employing 1,822% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
One more thing to note, Success Prime has decreased current liabilities to 29% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
Overall, Success Prime gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
One more thing, we've spotted 2 warning signs facing Success Prime that you might find interesting.
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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