Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Hengtong Optic-Electric (SHSE:600487), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Hengtong Optic-Electric is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = CN¥2.0b ÷ (CN¥60b - CN¥27b) (Based on the trailing twelve months to September 2023).
So, Hengtong Optic-Electric has an ROCE of 6.1%. In absolute terms, that's a low return, but it's much better than the Communications industry average of 5.1%.
View our latest analysis for Hengtong Optic-Electric
In the above chart we have measured Hengtong Optic-Electric'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 Hengtong Optic-Electric.
How Are Returns Trending?
On the surface, the trend of ROCE at Hengtong Optic-Electric doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. However it looks like Hengtong Optic-Electric might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Hengtong Optic-Electric has decreased its current liabilities to 45% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
What We Can Learn From Hengtong Optic-Electric's ROCE
Bringing it all together, while we're somewhat encouraged by Hengtong Optic-Electric's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 27% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
On a separate note, we've found 1 warning sign for Hengtong Optic-Electric you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.