What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Sun.King Technology Group (HKG:580) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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. To calculate this metric for Sun.King Technology Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.012 = CN¥23m ÷ (CN¥2.4b - CN¥399m) (Based on the trailing twelve months to December 2021).
So, Sun.King Technology Group has an ROCE of 1.2%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.7%.
See our latest analysis for Sun.King Technology Group
SEHK:580 Return on Capital Employed August 5th 2022Historical performance is a great place to start when researching a stock so above you can see the gauge for Sun.King Technology Group's ROCE against it's prior returns. If you're interested in investigating Sun.King Technology Group's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Sun.King Technology Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.2% from 14% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, Sun.King Technology Group has decreased its current liabilities to 17% 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.
The Bottom Line On Sun.King Technology Group's ROCE
We're a bit apprehensive about Sun.King Technology Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 80% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
On a final note, we found 2 warning signs for Sun.King Technology Group (1 doesn't sit too well with us) you should be aware of.
While Sun.King Technology Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.