Wah Lee Industrial's (TPE:3010) Returns Have Hit A Wall

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Wah Lee Industrial (TPE:3010), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Wah Lee Industrial:

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

0.10 = NT$2.1b ÷ (NT$39b - NT$18b) (Based on the trailing twelve months to December 2020).

Therefore, Wah Lee Industrial has an ROCE of 10.0%. Even though it's in line with the industry average of 10%, it's still a low return by itself.

See our latest analysis for Wah Lee Industrial

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're interested in investigating Wah Lee Industrial's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Wah Lee Industrial Tell Us?

In terms of Wah Lee Industrial's historical ROCE trend, it doesn't exactly demand attention. The company has employed 37% more capital in the last five years, and the returns on that capital have remained stable at 10.0%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a side note, Wah Lee Industrial's current liabilities are still rather high at 46% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Wah Lee Industrial's ROCE

Long story short, while Wah Lee Industrial has been reinvesting its capital, the returns that it's generating haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 143% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Wah Lee Industrial does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

While Wah Lee Industrial 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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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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