What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So on that note, Darfon Electronics (TPE:8163) looks quite promising in regards to its trends of return on capital.
Understanding 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 Darfon Electronics, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.092 = NT$1.0b ÷ (NT$23b - NT$11b) (Based on the trailing twelve months to September 2020).
Thus, Darfon Electronics has an ROCE of 9.2%. In absolute terms, that's a low return and it also under-performs the Tech industry average of 12%.
See our latest analysis for Darfon Electronics
In the above chart we have measured Darfon Electronics' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
Darfon Electronics is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 65% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 50% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
In Conclusion...
In summary, we're delighted to see that Darfon Electronics has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Since the stock has returned a staggering 219% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Darfon Electronics can keep these trends up, it could have a bright future ahead.
Like most companies, Darfon Electronics does come with some risks, and we've found 2 warning signs that you should be aware of.
While Darfon Electronics 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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About TWSE:8163
Darfon Electronics
Provides eco-friendly technologies for IT peripherals, passive components, and green energy solutions.
Excellent balance sheet, good value and pays a dividend.
