If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after we looked into Lagis Enterprise (GTSM:6730), the trends above didn't look too great.
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. Analysts use this formula to calculate it for Lagis Enterprise:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = NT$71m ÷ (NT$609m - NT$151m) (Based on the trailing twelve months to June 2020).
Therefore, Lagis Enterprise has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 12% it's much better.
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 Lagis Enterprise has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
There is reason to be cautious about Lagis Enterprise, given the returns are trending downwards. About three years ago, returns on capital were 23%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. 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 three years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Lagis Enterprise becoming one if things continue as they have.
Our Take On Lagis Enterprise'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. Investors haven't taken kindly to these developments, since the stock has declined 26% from where it was year ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing to note, we've identified 4 warning signs with Lagis Enterprise and understanding them should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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