Capital Allocation Trends At Solomon Technology (TWSE:2359) Aren't Ideal

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Solomon Technology (TWSE:2359) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Solomon Technology, this is the formula:

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

0.024 = NT$143m ÷ (NT$8.9b - NT$3.0b) (Based on the trailing twelve months to December 2023).

Thus, Solomon Technology has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 6.8%.

Check out our latest analysis for Solomon Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Solomon Technology's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Solomon Technology.

How Are Returns Trending?

On the surface, the trend of ROCE at Solomon Technology doesn't inspire confidence. Around five years ago the returns on capital were 3.1%, but since then they've fallen to 2.4%. 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, Solomon Technology's current liabilities have increased over the last five years to 34% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.4%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From Solomon Technology's ROCE

In summary, we're somewhat concerned by Solomon Technology's diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 389%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Solomon Technology we've found 2 warning signs (1 is concerning!) that you should be aware of before investing here.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.