What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Yem Chio's (TPE:4306) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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 Yem Chio, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = NT$583m ÷ (NT$31b - NT$14b) (Based on the trailing twelve months to September 2020).
So, Yem Chio has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Packaging industry average of 6.0%.
Check out our latest analysis for Yem Chio
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 Yem Chio, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased by 161% over the trailing five years. The company is now earning NT$0.03 per dollar of capital employed. In regards to capital employed, Yem Chio appears to been achieving more with less, since the business is using 26% less capital to run its operation. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
Another thing to note, Yem Chio has a high ratio of current liabilities to total assets of 44%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Yem Chio's ROCE
In the end, Yem Chio has proven it's capital allocation skills are good with those higher returns from less amount of capital. Considering the stock has delivered 39% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
If you'd like to know more about Yem Chio, we've spotted 4 warning signs, and 2 of them are significant.
While Yem Chio 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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About TWSE:4306
Yem Chio
Engages in researching, designing, manufacturing, processing, trading, and sale of packaging materials in Taiwan and internationally.
Solid track record, good value and pays a dividend.
