ELAN Microelectronics (TPE:2458) Knows How To Allocate Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Speaking of which, we noticed some great changes in ELAN Microelectronics' (TPE:2458) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

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 ELAN Microelectronics:

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

0.40 = NT$3.5b ÷ (NT$13b - NT$4.6b) (Based on the trailing twelve months to September 2020).

Thus, ELAN Microelectronics has an ROCE of 40%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

See our latest analysis for ELAN Microelectronics

In the above chart we have measured ELAN Microelectronics' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering ELAN Microelectronics here for free.

What Does the ROCE Trend For ELAN Microelectronics Tell Us?

ELAN Microelectronics has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 207% in that same time. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 35% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

Our Take On ELAN Microelectronics' ROCE

To sum it up, ELAN Microelectronics is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 277% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you want to know some of the risks facing ELAN Microelectronics we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

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