If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. 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 East GroupLtd (SZSE:300376), it didn't seem to tick all of these boxes.
What Is 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 East GroupLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.065 = CN¥687m ÷ (CN¥14b - CN¥3.4b) (Based on the trailing twelve months to September 2023).
Thus, East GroupLtd has an ROCE of 6.5%. Even though it's in line with the industry average of 6.3%, it's still a low return by itself.
See our latest analysis for East GroupLtd
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how East GroupLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
In terms of East GroupLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 6.5%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 side note, East GroupLtd has done well to pay down its current liabilities to 24% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by East GroupLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 41% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we found 2 warning signs for East GroupLtd (1 doesn't sit too well with us) you should be aware of.
While East GroupLtd 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.