When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within First Steamship (TPE:2601), we weren't too hopeful.
What is 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 First Steamship:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.028 = NT$642m ÷ (NT$34b - NT$11b) (Based on the trailing twelve months to September 2020).
Therefore, First Steamship has an ROCE of 2.8%. Even though it's in line with the industry average of 3.5%, it's still a low return by itself.
Historical performance is a great place to start when researching a stock so above you can see the gauge for First Steamship's ROCE against it's prior returns. If you're interested in investigating First Steamship's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is First Steamship's ROCE Trending?
We are a bit worried about the trend of returns on capital at First Steamship. About five years ago, returns on capital were 6.1%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect First Steamship to turn into a multi-bagger.
What We Can Learn From First Steamship'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 23% 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 First Steamship you'll probably want to know about.
While First Steamship 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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