Does Ledlink Optics' (GTSM:5230) Returns On Capital Reflect Well On The Business?

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. Having said that, after a brief look, Ledlink Optics (GTSM:5230) we aren't filled with optimism, but let's investigate further.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Ledlink Optics is:

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

0.0061 = NT$9.2m ÷ (NT$2.0b - NT$526m) (Based on the trailing twelve months to September 2020).

So, Ledlink Optics has an ROCE of 0.6%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 11%.

View our latest analysis for Ledlink Optics

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 want to delve into the historical earnings, revenue and cash flow of Ledlink Optics, check out these free graphs here.

So How Is Ledlink Optics' ROCE Trending?

There is reason to be cautious about Ledlink Optics, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 8.5% that they were earning five years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Ledlink Optics becoming one if things continue as they have.

On a side note, Ledlink Optics has done well to pay down its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. 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 Bottom Line

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 16% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 6 warning signs with Ledlink Optics (at least 2 which are concerning) , and understanding them would certainly be useful.

While Ledlink Optics 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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