Is Formosa Petrochemical (TPE:6505) Shrinking?

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at Formosa Petrochemical (TPE:6505), so let's see why.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Formosa Petrochemical is:

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

0.00003 = NT$12m ÷ (NT$349b - NT$25b) (Based on the trailing twelve months to September 2020).

Therefore, Formosa Petrochemical has an ROCE of 0.003%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 7.7%.

View our latest analysis for Formosa Petrochemical

In the above chart we have measured Formosa Petrochemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Formosa Petrochemical here for free.

The Trend Of ROCE

There is reason to be cautious about Formosa Petrochemical, given the returns are trending downwards. To be more specific, the ROCE was 4.6% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Formosa Petrochemical to turn into a multi-bagger.

Our Take On Formosa Petrochemical's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Yet despite these concerning fundamentals, the stock has performed strongly with a 57% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to continue researching Formosa Petrochemical, you might be interested to know about the 2 warning signs that our analysis has discovered.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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