Returns On Capital Signal Difficult Times Ahead For Gigastorage (TPE:2406)

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Gigastorage (TPE:2406), the trends above didn't look too great.

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. Analysts use this formula to calculate it for Gigastorage:

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

0.021 = NT$167m ÷ (NT$16b - NT$7.6b) (Based on the trailing twelve months to December 2020).

So, Gigastorage has an ROCE of 2.1%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 11%.

Check out our latest analysis for Gigastorage

Historical performance is a great place to start when researching a stock so above you can see the gauge for Gigastorage's ROCE against it's prior returns. If you're interested in investigating Gigastorage's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Gigastorage's historical ROCE trend, it isn't fantastic. The company used to generate 14% on its capital five years ago but it has since fallen noticeably. In addition to that, Gigastorage is now employing 43% less capital than it was five years ago. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a side note, Gigastorage's current liabilities have increased over the last five years to 49% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. Long term shareholders who've owned the stock over the last five years have experienced a 46% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Gigastorage (1 is potentially serious) you should be aware of.

While Gigastorage isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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