Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Coaster International (TPE:2936) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. Analysts use this formula to calculate it for Coaster International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.057 = NT$203m ÷ (NT$5.5b - NT$1.9b) (Based on the trailing twelve months to September 2020).
So, Coaster International has an ROCE of 5.7%. Even though it's in line with the industry average of 6.2%, it's still a low return by itself.
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 Coaster International, check out these free graphs here.
So How Is Coaster International's ROCE Trending?
In terms of Coaster International's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.7% from 8.4% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, Coaster International has decreased its current liabilities to 35% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 On Coaster International's ROCE
In summary, we're somewhat concerned by Coaster International's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 34% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
On a final note, we found 2 warning signs for Coaster International (1 is significant) you should be aware of.
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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