If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Although, when we looked at China Literature (HKG:772), it didn't seem to tick all of these boxes.
What Is 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. The formula for this calculation on China Literature is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = CN¥733m ÷ (CN¥22b - CN¥3.2b) (Based on the trailing twelve months to June 2023).
Thus, China Literature has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Media industry average of 8.7%.
View our latest analysis for China Literature
Above you can see how the current ROCE for China Literature compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Literature.
What Does the ROCE Trend For China Literature Tell Us?
On the surface, the trend of ROCE at China Literature doesn't inspire confidence. Around five years ago the returns on capital were 5.1%, but since then they've fallen to 3.8%. 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.
What We Can Learn From China Literature's ROCE
We're a bit apprehensive about China Literature because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 23% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One more thing to note, we've identified 1 warning sign with China Literature and understanding it should be part of your investment process.
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.