When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Level Biotechnology (GTSM:3118), we weren't too hopeful.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Level Biotechnology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = NT$66m ÷ (NT$773m - NT$225m) (Based on the trailing twelve months to December 2020).
So, Level Biotechnology has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 8.0% generated by the Healthcare industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Level Biotechnology has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Level Biotechnology Tell Us?
There is reason to be cautious about Level Biotechnology, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 16% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. 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 Level Biotechnology to turn into a multi-bagger.
In summary, it's unfortunate that Level Biotechnology is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 11% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
One more thing: We've identified 3 warning signs with Level Biotechnology (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.
While Level Biotechnology may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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