How Do Taiwan Alpha Electronic Co., Ltd.’s (GTSM:6204) Returns On Capital Compare To Peers?

Today we are going to look at Taiwan Alpha Electronic Co., Ltd. (GTSM:6204) to see whether it might be an attractive investment prospect. Specifically, we're going to calculate its Return On Capital Employed (ROCE), in the hopes of getting some insight into the business.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. In general, businesses with a higher ROCE are usually better quality. Ultimately, it is a useful but imperfect metric. Author Edwin Whiting says to be careful when comparing the ROCE of different businesses, since 'No two businesses are exactly alike.

So, How Do We Calculate ROCE?

Analysts use this formula to calculate return on capital employed:

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

Or for Taiwan Alpha Electronic:

0.028 = NT$24m ÷ (NT$1.1b - NT$227m) (Based on the trailing twelve months to September 2019.)

Therefore, Taiwan Alpha Electronic has an ROCE of 2.8%.

View our latest analysis for Taiwan Alpha Electronic

Is Taiwan Alpha Electronic's ROCE Good?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Taiwan Alpha Electronic's ROCE appears meaningfully below the 8.4% average reported by the Electronic industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Independently of how Taiwan Alpha Electronic compares to its industry, its ROCE in absolute terms is low; especially compared to the ~0.7% available in government bonds. There are potentially more appealing investments elsewhere.

Taiwan Alpha Electronic's current ROCE of 2.8% is lower than 3 years ago, when the company reported a 4.8% ROCE. This makes us wonder if the business is facing new challenges. You can see in the image below how Taiwan Alpha Electronic's ROCE compares to its industry. Click to see more on past growth.

Remember that this metric is backwards looking - it shows what has happened in the past, and does not accurately predict the future. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. If Taiwan Alpha Electronic is cyclical, it could make sense to check out this free graph of past earnings, revenue and cash flow.

What Are Current Liabilities, And How Do They Affect Taiwan Alpha Electronic's ROCE?

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To check the impact of this, we calculate if a company has high current liabilities relative to its total assets.

Taiwan Alpha Electronic has total assets of NT$1.1b and current liabilities of NT$227m. Therefore its current liabilities are equivalent to approximately 21% of its total assets. This is not a high level of current liabilities, which would not boost the ROCE by much.

The Bottom Line On Taiwan Alpha Electronic's ROCE

While that is good to see, Taiwan Alpha Electronic has a low ROCE and does not look attractive in this analysis. But note: make sure you look for a great company, not just the first idea you come across. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

I will like Taiwan Alpha Electronic better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.