Here's What's Concerning About DrayTek (TPE:6216)

What underlying fundamental trends can indicate that a company might be in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, DrayTek (TPE:6216) we aren't filled with optimism, but let's investigate further.

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. Analysts use this formula to calculate it for DrayTek:

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

0.10 = NT$153m ÷ (NT$1.8b - NT$315m) (Based on the trailing twelve months to September 2020).

Thus, DrayTek has an ROCE of 10%. By itself that's a normal return on capital and it's in line with the industry's average returns of 9.8%.

Check out our latest analysis for DrayTek

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'd like to look at how DrayTek has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

There is reason to be cautious about DrayTek, given the returns are trending downwards. To be more specific, the ROCE was 19% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on DrayTek becoming one if things continue as they have.

The Bottom Line

In summary, it's unfortunate that DrayTek is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 44% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we found 4 warning signs for DrayTek (2 are a bit unpleasant) you should be aware of.

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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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