Are Investors Concerned With What's Going On At U.D.Electronic (GTSM:3689)?

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into U.D.Electronic (GTSM:3689), we weren't too upbeat about how things were going.

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. To calculate this metric for U.D.Electronic, this is the formula:

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

0.045 = NT$121m ÷ (NT$5.8b - NT$3.1b) (Based on the trailing twelve months to September 2020).

So, U.D.Electronic has an ROCE of 4.5%. Ultimately, that's a low return and it under-performs the Electronic industry average of 11%.

Check out our latest analysis for U.D.Electronic

Historical performance is a great place to start when researching a stock so above you can see the gauge for U.D.Electronic's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of U.D.Electronic, check out these free graphs here.

What Does the ROCE Trend For U.D.Electronic Tell Us?

We are a bit worried about the trend of returns on capital at U.D.Electronic. Unfortunately the returns on capital have diminished from the 9.3% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on U.D.Electronic becoming one if things continue as they have.

On a side note, U.D.Electronic's current liabilities have increased over the last five years to 53% 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. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. In spite of that, the stock has delivered a 9.5% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with U.D.Electronic (including 1 which is a bit unpleasant) .

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. 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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