To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating Chunghwa Precision Test Tech (GTSM:6510), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Chunghwa Precision Test Tech:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = NT$1.2b ÷ (NT$8.0b - NT$1.1b) (Based on the trailing twelve months to September 2020).
So, Chunghwa Precision Test Tech has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 11% it's much better.
Above you can see how the current ROCE for Chunghwa Precision Test Tech compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Chunghwa Precision Test Tech's ROCE Trend?
In terms of Chunghwa Precision Test Tech's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 36%, but since then they've fallen to 18%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Chunghwa Precision Test Tech has done well to pay down its current liabilities to 14% 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
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Chunghwa Precision Test Tech. And long term investors must be optimistic going forward because the stock has returned a huge 104% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you'd like to know about the risks facing Chunghwa Precision Test Tech, we've discovered 1 warning sign that you should be aware of.
While Chunghwa Precision Test Tech 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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