If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it’s a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in ADDCN Technology’s (GTSM:5287) returns on capital, so let’s have a look.
What is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ADDCN Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.43 = NT$739m ÷ (NT$2.6b – NT$910m) (Based on the trailing twelve months to September 2020).
So, ADDCN Technology has an ROCE of 43%. In absolute terms that’s a great return and it’s even better than the Interactive Media and Services industry average of 14%.
Check out our latest analysis for ADDCN Technology
In the above chart we have measured ADDCN Technology’s prior ROCE against its prior performance, but the future is arguably more important. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For ADDCN Technology Tell Us?
ADDCN Technology is showing promise given that its ROCE is trending up and to the right. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 41% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It’s worth looking deeper into this though because while it’s great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 35% of its operations, which isn’t ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Key Takeaway
As discussed above, ADDCN Technology appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.
Since virtually every company faces some risks, it’s worth knowing what they are, and we’ve spotted 2 warning signs for ADDCN Technology (of which 1 can’t be ignored!) that you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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