Epoch Chemtronics (GTSM:3633) Might Be Having Difficulty Using Its Capital Effectively

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Epoch Chemtronics (GTSM:3633) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Epoch Chemtronics:

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

0.054 = NT$71m ÷ (NT$2.4b - NT$1.1b) (Based on the trailing twelve months to December 2020).

So, Epoch Chemtronics has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 11%.

See our latest analysis for Epoch Chemtronics

Historical performance is a great place to start when researching a stock so above you can see the gauge for Epoch Chemtronics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Epoch Chemtronics, check out these free graphs here.

How Are Returns Trending?

On the surface, the trend of ROCE at Epoch Chemtronics doesn't inspire confidence. To be more specific, ROCE has fallen from 24% over the last five years. 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 side note, Epoch Chemtronics has done well to pay down its current liabilities to 47% 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. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Epoch Chemtronics have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 129% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing: We've identified 3 warning signs with Epoch Chemtronics (at least 1 which is significant) , and understanding these would certainly be useful.

While Epoch Chemtronics 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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