Returns On Capital Signal Tricky Times Ahead For Formosa Optical TechnologyLtd (GTSM:5312)

What trends should we look for it we want to identify stocks that can 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Formosa Optical TechnologyLtd (GTSM:5312), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 Formosa Optical TechnologyLtd:

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

0.032 = NT$128m ÷ (NT$5.7b - NT$1.6b) (Based on the trailing twelve months to September 2020).

Thus, Formosa Optical TechnologyLtd has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 8.4%.

View our latest analysis for Formosa Optical TechnologyLtd

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Formosa Optical TechnologyLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.2% from 5.9% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Key Takeaway

To conclude, we've found that Formosa Optical TechnologyLtd is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 1.6% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Formosa Optical TechnologyLtd, we've discovered 1 warning sign that you should be aware of.

While Formosa Optical TechnologyLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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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