What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think TWOWAY Communications (GTSM:8045) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on TWOWAY Communications is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = NT$69m ÷ (NT$2.0b - NT$332m) (Based on the trailing twelve months to June 2020).
Thus, TWOWAY Communications has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 9.8%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for TWOWAY Communications' ROCE against it's prior returns. If you're interested in investigating TWOWAY Communications' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of TWOWAY Communications' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.1% from 9.3% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, TWOWAY Communications has done well to pay down its current liabilities to 16% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for TWOWAY Communications have fallen, meanwhile the business is employing more capital than it was five years ago. And, the stock has remained flat over the last three years, so investors don't seem too impressed either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing, we've spotted 4 warning signs facing TWOWAY Communications that you might find interesting.
While TWOWAY Communications isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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