The Returns At Utechzone (GTSM:3455) Provide Us With Signs Of What's To Come

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Utechzone (GTSM:3455) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Utechzone, this is the formula:

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

0.046 = NT$107m ÷ (NT$4.0b - NT$1.7b) (Based on the trailing twelve months to September 2020).

Thus, Utechzone has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Electronic industry average of 11%.

See our latest analysis for Utechzone

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

What Can We Tell From Utechzone's ROCE Trend?

In terms of Utechzone's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 4.6%. And considering revenue has dropped while employing more capital, we'd be cautious. 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 side note, Utechzone's current liabilities have increased over the last five years to 42% 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.

What We Can Learn From Utechzone's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Utechzone have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 130% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 2 warning signs for Utechzone that we think you should be aware of.

While Utechzone may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. 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.
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