Favite (TWSE:3535) Could Be At Risk Of Shrinking As A Company

If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. So after we looked into Favite (TWSE:3535), the trends above didn't look too great.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Favite, this is the formula:

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

0.075 = NT$106m ÷ (NT$1.7b - NT$317m) (Based on the trailing twelve months to June 2024).

Therefore, Favite has an ROCE of 7.5%. In absolute terms, that's a low return but it's around the Electronic industry average of 6.9%.

Check out our latest analysis for Favite

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're interested in investigating Favite's past further, check out this free graph covering Favite's past earnings, revenue and cash flow.

What Can We Tell From Favite's ROCE Trend?

We are a bit worried about the trend of returns on capital at Favite. To be more specific, the ROCE was 16% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Favite becoming one if things continue as they have.

On a related note, Favite has decreased its current liabilities to 18% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Favite's ROCE

In summary, it's unfortunate that Favite is generating lower returns from the same amount of capital. Since the stock has skyrocketed 167% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Favite does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...

While Favite 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. 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.