Formosa Petrochemical (TWSE:6505) Could Be At Risk Of Shrinking As A Company

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. 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. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Formosa Petrochemical (TWSE:6505) we aren't filled with optimism, but let's investigate further.

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 Formosa Petrochemical:

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

0.04 = NT$14b ÷ (NT$419b - NT$62b) (Based on the trailing twelve months to March 2024).

So, Formosa Petrochemical has an ROCE of 4.0%. In absolute terms, that's a low return and it also under-performs the Oil and Gas industry average of 10%.

Check out our latest analysis for Formosa Petrochemical

Above you can see how the current ROCE for Formosa Petrochemical compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Formosa Petrochemical .

What Does the ROCE Trend For Formosa Petrochemical Tell Us?

We are a bit worried about the trend of returns on capital at Formosa Petrochemical. About five years ago, returns on capital were 15%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Formosa Petrochemical becoming one if things continue as they have.

The Bottom Line

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. Investors haven't taken kindly to these developments, since the stock has declined 31% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Formosa Petrochemical does have some risks though, and we've spotted 1 warning sign for Formosa Petrochemical that you might be interested in.

While Formosa Petrochemical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com