Cathay Chemical Works (TPE:1713) Is Finding It Tricky To Allocate Its Capital

What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. On that note, looking into Cathay Chemical Works (TPE:1713), we weren't too upbeat about how things were going.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Cathay Chemical Works:

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

0.007 = NT$17m ÷ (NT$2.5b - NT$30m) (Based on the trailing twelve months to December 2020).

Therefore, Cathay Chemical Works has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 7.7%.

View our latest analysis for Cathay Chemical Works

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cathay Chemical Works' ROCE against it's prior returns. If you'd like to look at how Cathay Chemical Works has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Cathay Chemical Works' ROCE Trending?

There is reason to be cautious about Cathay Chemical Works, given the returns are trending downwards. To be more specific, the ROCE was 2.0% 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. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Cathay Chemical Works becoming one if things continue as they have.

The Bottom Line On Cathay Chemical Works' ROCE

In summary, it's unfortunate that Cathay Chemical Works is generating lower returns from the same amount of capital. However the stock has delivered a 77% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 1 warning sign with Cathay Chemical Works and understanding this should be part of your investment process.

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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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