What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Information Technology Total Services (GTSM:6697) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Information Technology Total Services:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = NT$62m ÷ (NT$831m - NT$218m) (Based on the trailing twelve months to September 2020).
Therefore, Information Technology Total Services has an ROCE of 10%. In isolation, that's a pretty standard return but against the Software industry average of 19%, it's not as good.
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 Information Technology Total Services has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Information Technology Total Services doesn't inspire confidence. Around four years ago the returns on capital were 18%, but since then they've fallen to 10%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.On a related note, Information Technology Total Services has decreased its current liabilities to 26% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
In summary, we're somewhat concerned by Information Technology Total Services' diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last year. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a final note, we've found 2 warning signs for Information Technology Total Services that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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