If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Speaking of which, we noticed some great changes in Sensortek Technology's (GTSM:6732) returns on capital, so let's have a look.
Understanding 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. Analysts use this formula to calculate it for Sensortek Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.36 = NT$1.6b ÷ (NT$5.7b - NT$1.3b) (Based on the trailing twelve months to September 2020).
Thus, Sensortek Technology has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Electronic industry average of 10%.
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 Sensortek Technology, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
Sensortek Technology is displaying some positive trends. Over the last three years, returns on capital employed have risen substantially to 36%. The amount of capital employed has increased too, by 1,561%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a related note, the company's ratio of current liabilities to total assets has decreased to 23%, which basically reduces it's funding from the likes of short-term creditors or suppliers. This tells us that Sensortek Technology has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Key Takeaway
All in all, it's terrific to see that Sensortek Technology is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a solid 24% to shareholders over the last year, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Sensortek Technology does have some risks though, and we've spotted 2 warning signs for Sensortek Technology that you might be interested in.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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