Radiant Opto-Electronics (TWSE:6176) Will Want To Turn Around Its Return Trends

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Radiant Opto-Electronics (TWSE:6176), it didn't seem to tick all of these boxes.

Understanding 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. To calculate this metric for Radiant Opto-Electronics, this is the formula:

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

0.16 = NT$5.9b ÷ (NT$60b - NT$22b) (Based on the trailing twelve months to June 2024).

Thus, Radiant Opto-Electronics has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 8.8% it's much better.

View our latest analysis for Radiant Opto-Electronics

In the above chart we have measured Radiant Opto-Electronics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Radiant Opto-Electronics .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Radiant Opto-Electronics doesn't inspire confidence. To be more specific, ROCE has fallen from 27% over the last five years. 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 related note, Radiant Opto-Electronics has decreased its current liabilities to 37% 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.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Radiant Opto-Electronics have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 135% over the last five years, so investors appear very optimistic. 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 final note, you should learn about the 2 warning signs we've spotted with Radiant Opto-Electronics (including 1 which makes us a bit uncomfortable) .

While Radiant Opto-Electronics 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.