Headway Advanced Materials (TPE:1776) Could Be Struggling To Allocate Capital

What underlying fundamental trends can indicate that a company might be in decline? 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. Basically the company is earning less on its investments and it is also reducing its total assets. And from a first read, things don't look too good at Headway Advanced Materials (TPE:1776), so let's see why.

Return On Capital Employed (ROCE): What is it?

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. The formula for this calculation on Headway Advanced Materials is:

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

0.068 = NT$93m ÷ (NT$1.9b - NT$539m) (Based on the trailing twelve months to December 2020).

Thus, Headway Advanced Materials has an ROCE of 6.8%. In absolute terms, that's a low return but it's around the Chemicals industry average of 7.8%.

See our latest analysis for Headway Advanced Materials

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

So How Is Headway Advanced Materials' ROCE Trending?

In terms of Headway Advanced Materials' historical ROCE movements, the trend doesn't inspire confidence. Unfortunately the returns on capital have diminished from the 12% that they were earning five years ago. 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 five years. If these trends continue, we wouldn't expect Headway Advanced Materials to turn into a multi-bagger.

What We Can Learn From Headway Advanced Materials' ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Long term shareholders who've owned the stock over the last five years have experienced a 27% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Headway Advanced Materials (including 1 which makes us a bit uncomfortable) .

While Headway Advanced Materials isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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