If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Nanya Technology (TPE:2408) and its ROCE trend, we weren’t exactly thrilled.
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 Nanya Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.054 = NT$8.4b ÷ (NT$166b – NT$8.8b) (Based on the trailing twelve months to December 2020).
So, Nanya Technology has an ROCE of 5.4%. Ultimately, that’s a low return and it under-performs the Semiconductor industry average of 10%.
In the above chart we have measured Nanya Technology’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like to see what analysts are forecasting going forward, you should check out our free report for Nanya Technology.
What Can We Tell From Nanya Technology’s ROCE Trend?
On the surface, the trend of ROCE at Nanya Technology doesn’t inspire confidence. Over the last five years, returns on capital have decreased to 5.4% from 19% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Nanya Technology has done well to pay down its current liabilities to 5.3% 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. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Nanya Technology. And long term investors must be optimistic going forward because the stock has returned a huge 206% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you’d like to know about the risks facing Nanya Technology, we’ve discovered 1 warning sign that you should be aware of.
While Nanya 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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