Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates the company is producing less profit from its investments and its total assets are decreasing. Having said that, after a brief look, Solomon Technology (TPE:2359) we aren’t filled with optimism, but let’s investigate further.
Understanding Return On Capital Employed (ROCE)
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. The formula for this calculation on Solomon Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.0095 = NT$47m ÷ (NT$6.5b – NT$1.5b) (Based on the trailing twelve months to December 2020).
Therefore, Solomon Technology has an ROCE of 1.0%. In absolute terms, that’s a low return and it also under-performs the Electronic industry average of 10%.
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 want to delve into the historical earnings, revenue and cash flow of Solomon Technology, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We are a bit worried about the trend of returns on capital at Solomon Technology. Unfortunately the returns on capital have diminished from the 5.4% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Solomon Technology to turn into a multi-bagger.
Our Take On Solomon Technology’s ROCE
In summary, it’s unfortunate that Solomon Technology is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 39% 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.
Solomon Technology does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
While Solomon Technology 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. 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.
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