Why Ecocera Optronics Co., Ltd.’s (GTSM:6597) Return On Capital Employed Looks Uninspiring

Today we are going to look at Ecocera Optronics Co., Ltd. (GTSM:6597) 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.

Firstly, we’ll go over how we calculate ROCE. Then we’ll compare its ROCE to similar companies. Finally, we’ll look at how its current liabilities affect its ROCE.

What is Return On Capital Employed (ROCE)?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. In general, businesses with a higher ROCE are usually better quality. In brief, it is a useful tool, but it is not without drawbacks. 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?

The formula for calculating the return on capital employed is:

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

Or for Ecocera Optronics:

0.067 = NT$18m ÷ (NT$636m – NT$365m) (Based on the trailing twelve months to June 2019.)

Therefore, Ecocera Optronics has an ROCE of 6.7%.

View our latest analysis for Ecocera Optronics

Does Ecocera Optronics Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. In this analysis, Ecocera Optronics’s ROCE appears meaningfully below the 8.4% average reported by the Electronic industry. This performance could be negative if sustained, as it suggests the business may underperform its industry. Setting aside the industry comparison for now, Ecocera Optronics’s ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Readers may find more attractive investment prospects elsewhere.

Ecocera Optronics delivered an ROCE of 6.7%, which is better than 3 years ago, as was making losses back then. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Ecocera Optronics’s past growth compares to other companies.

GTSM:6597 Past Revenue and Net Income, January 16th 2020
GTSM:6597 Past Revenue and Net Income, January 16th 2020

When considering ROCE, bear in mind that it reflects the past and does not necessarily predict the future. ROCE can be deceptive for cyclical businesses, as returns can look incredible in boom times, and terribly low in downturns. ROCE is, after all, simply a snap shot of a single year. If Ecocera Optronics 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 Ecocera Optronics’s ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Ecocera Optronics has total assets of NT$636m and current liabilities of NT$365m. Therefore its current liabilities are equivalent to approximately 57% of its total assets. Ecocera Optronics’s current liabilities are fairly high, making its ROCE look better than otherwise.

What We Can Learn From Ecocera Optronics’s ROCE

Notably, it also has a mediocre ROCE, which to my mind is not an appealing combination. Of course, you might also be able to find a better stock than Ecocera Optronics. So you may wish to see this free collection of other companies that have grown earnings strongly.

I will like Ecocera Optronics 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.

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