Asia Optical (TWSE:3019) May Have Issues Allocating Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This combination can tell you that not only is the company investing less, it's earning less on what it does invest. And from a first read, things don't look too good at Asia Optical (TWSE:3019), so let's see why.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Asia Optical is:

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

0.065 = NT$1.0b ÷ (NT$24b - NT$7.6b) (Based on the trailing twelve months to June 2024).

So, Asia Optical has an ROCE of 6.5%. In absolute terms, that's a low return but it's around the Electronic industry average of 6.7%.

View our latest analysis for Asia Optical

In the above chart we have measured Asia Optical's 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 analyst report for Asia Optical .

What Can We Tell From Asia Optical's ROCE Trend?

There is reason to be cautious about Asia Optical, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 9.9% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Asia Optical to turn into a multi-bagger.

What We Can Learn From Asia Optical's ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Despite the concerning underlying trends, the stock has actually gained 32% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

On a separate note, we've found 1 warning sign for Asia Optical you'll probably want to know about.

While Asia Optical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.