Micro-Star International (TWSE:2377) Could Be Struggling To Allocate Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Having said that, from a first glance at Micro-Star International (TWSE:2377) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for Micro-Star International, this is the formula:

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

0.15 = NT$7.8b ÷ (NT$99b - NT$48b) (Based on the trailing twelve months to September 2023).

So, Micro-Star International has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Tech industry average of 11% it's much better.

Check out our latest analysis for Micro-Star International

In the above chart we have measured Micro-Star International's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Micro-Star International .

The Trend Of ROCE

On the surface, the trend of ROCE at Micro-Star International doesn't inspire confidence. To be more specific, ROCE has fallen from 25% over the last five years. 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 separate but related note, it's important to know that Micro-Star International has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. 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.

What We Can Learn From Micro-Star International's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Micro-Star International have fallen, meanwhile the business is employing more capital than it was five years ago. Since the stock has skyrocketed 187% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing, we've spotted 2 warning signs facing Micro-Star International that you might find interesting.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.