Here's What's Concerning About Qualipoly Chemical (TPE:4722)

What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. So after we looked into Qualipoly Chemical (TPE:4722), the trends above didn't look too great.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Qualipoly Chemical is:

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

0.13 = NT$331m ÷ (NT$3.1b - NT$599m) (Based on the trailing twelve months to September 2020).

Therefore, Qualipoly Chemical has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 6.7% it's much better.

Check out our latest analysis for Qualipoly Chemical

In the above chart we have measured Qualipoly Chemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Qualipoly Chemical.

What Can We Tell From Qualipoly Chemical's ROCE Trend?

We are a bit worried about the trend of returns on capital at Qualipoly Chemical. About five years ago, returns on capital were 18%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Qualipoly Chemical becoming one if things continue as they have.

On a related note, Qualipoly Chemical has decreased its current liabilities to 19% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

In summary, it's unfortunate that Qualipoly Chemical is generating lower returns from the same amount of capital. Investors must expect better things on the horizon though because the stock has risen 33% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

One more thing: We've identified 2 warning signs with Qualipoly Chemical (at least 1 which is potentially serious) , and understanding them would certainly be useful.

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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