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. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Alcorlink (GTSM:6594) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Alcorlink, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = NT$29m ÷ (NT$542m - NT$125m) (Based on the trailing twelve months to September 2020).
Thus, Alcorlink has an ROCE of 7.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 11%.
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're interested in investigating Alcorlink's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Alcorlink Tell Us?
On the surface, the trend of ROCE at Alcorlink doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.0% from 13% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Alcorlink's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 21% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
If you'd like to know about the risks facing Alcorlink, we've discovered 3 warning signs that you should be aware of.
While Alcorlink 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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