What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating PowerTECH (SZSE:301369), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for PowerTECH:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0066 = CN¥9.6m ÷ (CN¥1.6b - CN¥116m) (Based on the trailing twelve months to September 2023).
Therefore, PowerTECH has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 5.5%.
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 PowerTECH's past further, check out this free graph covering PowerTECH's past earnings, revenue and cash flow.
What Does the ROCE Trend For PowerTECH Tell Us?
On the surface, the trend of ROCE at PowerTECH doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.7% from 37% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, PowerTECH has decreased its current liabilities to 7.4% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From PowerTECH's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for PowerTECH have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 17% over the last year, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
PowerTECH does have some risks, we noticed 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.