Capital Allocation Trends At Sercomm (TPE:5388) Aren't Ideal

There are a few key trends to look for if we want to identify the next multi-bagger. 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 briefly looking over the numbers, we don't think Sercomm (TPE:5388) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Sercomm, this is the formula:

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

0.096 = NT$1.1b ÷ (NT$31b - NT$19b) (Based on the trailing twelve months to December 2020).

So, Sercomm has an ROCE of 9.6%. On its own that's a low return, but compared to the average of 8.0% generated by the Communications industry, it's much better.

Check out our latest analysis for Sercomm

In the above chart we have measured Sercomm's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sercomm here for free.

What Can We Tell From Sercomm's ROCE Trend?

On the surface, the trend of ROCE at Sercomm doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 9.6%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Another thing to note, Sercomm has a high ratio of current liabilities to total assets of 61%. 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.

The Bottom Line On Sercomm's ROCE

While returns have fallen for Sercomm in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 29% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you want to know some of the risks facing Sercomm we've found 3 warning signs (1 is concerning!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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