Investors Could Be Concerned With Rafael Microelectronics' (GTSM:6568) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Although, when we looked at Rafael Microelectronics (GTSM:6568), it didn't seem to tick all of these boxes.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Rafael Microelectronics:

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

0.13 = NT$181m ÷ (NT$1.6b - NT$276m) (Based on the trailing twelve months to September 2020).

Therefore, Rafael Microelectronics has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Semiconductor industry average of 11%.

Check out our latest analysis for Rafael Microelectronics

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'd like to look at how Rafael Microelectronics has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Rafael Microelectronics' ROCE Trending?

On the surface, the trend of ROCE at Rafael Microelectronics doesn't inspire confidence. Over the last five years, returns on capital have decreased to 13% from 24% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Rafael Microelectronics has done well to pay down its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. 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.

In Conclusion...

We're a bit apprehensive about Rafael Microelectronics because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 16% 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.

If you want to know some of the risks facing Rafael Microelectronics we've found 3 warning signs (1 is a bit concerning!) that you should be aware of before investing here.

While Rafael Microelectronics 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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