Capital Allocation Trends At Scientech (TWSE:3583) 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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Scientech (TWSE:3583), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. Analysts use this formula to calculate it for Scientech:

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

0.15 = NT$900m ÷ (NT$22b - NT$16b) (Based on the trailing twelve months to June 2024).

Thus, Scientech has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 6.8% it's much better.

See our latest analysis for Scientech

Historical performance is a great place to start when researching a stock so above you can see the gauge for Scientech's ROCE against it's prior returns. If you're interested in investigating Scientech's past further, check out this free graph covering Scientech's past earnings, revenue and cash flow.

What Does the ROCE Trend For Scientech Tell Us?

On the surface, the trend of ROCE at Scientech doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 24% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 73%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 15%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

While returns have fallen for Scientech in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 936% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Like most companies, Scientech does come with some risks, and we've found 1 warning sign that you should be aware of.

While Scientech 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.