Returns On Capital At Groundhog (TWSE:6906) Paint A Concerning Picture

There are a few key trends to look for if we want to identify the next multi-bagger. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Groundhog (TWSE:6906), we don't think it's current trends fit the mold of a multi-bagger.

What Is 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 Groundhog:

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

0.13 = NT$121m ÷ (NT$1.0b - NT$126m) (Based on the trailing twelve months to September 2024).

Therefore, Groundhog has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 14% generated by the Software industry.

Check out our latest analysis for Groundhog

In the above chart we have measured Groundhog's 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 Groundhog for free.

How Are Returns Trending?

We weren't thrilled with the trend because Groundhog's ROCE has reduced by 43% over the last four years, while the business employed 125% more capital. That being said, Groundhog raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Groundhog's earnings and if they change as a result from the capital raise.

On a side note, Groundhog has done well to pay down its current liabilities to 12% 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Groundhog is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 19% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a final note, we found 4 warning signs for Groundhog (1 makes us a bit uncomfortable) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.