Be Wary Of Pegatron (TWSE:4938) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Pegatron (TWSE:4938), it didn't seem to tick all of these boxes.

What Is 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 Pegatron, this is the formula:

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

0.05 = NT$14b ÷ (NT$635b - NT$351b) (Based on the trailing twelve months to September 2024).

Therefore, Pegatron has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Tech industry average of 12%.

Check out our latest analysis for Pegatron

Above you can see how the current ROCE for Pegatron compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Pegatron .

What Can We Tell From Pegatron's ROCE Trend?

Unfortunately, the trend isn't great with ROCE falling from 6.5% five years ago, while capital employed has grown 29%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Pegatron probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a separate but related note, it's important to know that Pegatron has a current liabilities to total assets ratio of 55%, 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.

The Bottom Line On Pegatron's ROCE

In summary, we're somewhat concerned by Pegatron's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 110% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Like most companies, Pegatron does come with some risks, and we've found 2 warning signs that you should be aware of.

While Pegatron 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.