If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So, when we ran our eye over Chengdu Hongqi ChainLtd's (SZSE:002697) trend of ROCE, we liked what we saw.
Understanding 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. To calculate this metric for Chengdu Hongqi ChainLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = CN¥465m ÷ (CN¥7.9b - CN¥3.3b) (Based on the trailing twelve months to September 2023).
Therefore, Chengdu Hongqi ChainLtd has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Consumer Retailing industry average of 7.0% it's much better.
Check out our latest analysis for Chengdu Hongqi ChainLtd
Above you can see how the current ROCE for Chengdu Hongqi ChainLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
While the returns on capital are good, they haven't moved much. The company has consistently earned 10% for the last five years, and the capital employed within the business has risen 78% in that time. 10% is a pretty standard return, and it provides some comfort knowing that Chengdu Hongqi ChainLtd has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
Another thing to note, Chengdu Hongqi ChainLtd has a high ratio of current liabilities to total assets of 42%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Chengdu Hongqi ChainLtd's ROCE
In the end, Chengdu Hongqi ChainLtd has proven its ability to adequately reinvest capital at good rates of return. And given the stock has only risen 11% over the last five years, we'd suspect the market is beginning to recognize these trends. So because of the trends we're seeing, we'd recommend looking further into this stock to see if it has the makings of a multi-bagger.
Chengdu Hongqi ChainLtd does have some risks though, and we've spotted 1 warning sign for Chengdu Hongqi ChainLtd that you might be interested in.
While Chengdu Hongqi ChainLtd 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.