Returns On Capital At Cathay Chemical Works (TPE:1713) Paint A Concerning Picture

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Cathay Chemical Works (TPE:1713) we aren't filled with optimism, but let's investigate further.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Cathay Chemical Works, this is the formula:

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

0.0063 = NT$15m ÷ (NT$2.4b - NT$35m) (Based on the trailing twelve months to September 2020).

Thus, Cathay Chemical Works has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.7%.

Check out our latest analysis for Cathay Chemical Works

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 Cathay Chemical Works has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Cathay Chemical Works' ROCE Trend?

In terms of Cathay Chemical Works' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 2.3% 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 Cathay Chemical Works to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that Cathay Chemical Works is generating lower returns from the same amount of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 51% return. 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.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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