Is Headway Advanced Materials (TPE:1776) Using Capital Effectively?

When researching a stock for investment, what can tell us that the company is in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. Having said that, after a brief look, Headway Advanced Materials (TPE:1776) we aren't filled with optimism, but let's investigate further.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Headway Advanced Materials:

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

0.054 = NT$72m ÷ (NT$1.8b - NT$512m) (Based on the trailing twelve months to September 2020).

Therefore, Headway Advanced Materials has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Chemicals industry average of 6.7%.

See our latest analysis for Headway Advanced Materials

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 want to delve into the historical earnings, revenue and cash flow of Headway Advanced Materials, check out these free graphs here.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Headway Advanced Materials. About five years ago, returns on capital were 9.6%, 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. If these trends continue, we wouldn't expect Headway Advanced Materials to turn into a multi-bagger.

In Conclusion...

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 36% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Headway Advanced Materials, we've spotted 3 warning signs, and 1 of them is a bit concerning.

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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