What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Speaking of which, we noticed some great changes in Edifier Technology's (SZSE:002351) returns on capital, so let's have a look.
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 Edifier Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = CN¥398m ÷ (CN¥3.2b - CN¥659m) (Based on the trailing twelve months to September 2023).
Therefore, Edifier Technology has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 7.7% generated by the Consumer Durables industry.
View our latest analysis for Edifier Technology
In the above chart we have measured Edifier 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 Edifier Technology.
What Can We Tell From Edifier Technology's ROCE Trend?
Edifier Technology is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 16%. Basically the business is earning more per dollar of capital invested and in addition to that, 40% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 21% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
In Conclusion...
To sum it up, Edifier Technology has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Edifier Technology can keep these trends up, it could have a bright future ahead.
If you want to continue researching Edifier Technology, you might be interested to know about the 2 warning signs that our analysis has discovered.
While Edifier 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. 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.