Should You Be Worried About Taiwan Fertilizer's (TPE:1722) Returns On Capital?

When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Taiwan Fertilizer (TPE:1722), we weren't too hopeful.

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. To calculate this metric for Taiwan Fertilizer, this is the formula:

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

0.022 = NT$1.6b ÷ (NT$76b - NT$2.6b) (Based on the trailing twelve months to September 2020).

Therefore, Taiwan Fertilizer has an ROCE of 2.2%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 6.7%.

Check out our latest analysis for Taiwan Fertilizer

In the above chart we have measured Taiwan Fertilizer's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Taiwan Fertilizer here for free.

What Does the ROCE Trend For Taiwan Fertilizer Tell Us?

There is reason to be cautious about Taiwan Fertilizer, given the returns are trending downwards. About five years ago, returns on capital were 4.8%, 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 Taiwan Fertilizer becoming one if things continue as they have.

The Key Takeaway

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. However the stock has delivered a 59% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Like most companies, Taiwan Fertilizer does come with some risks, and we've found 2 warning signs that you should be aware of.

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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