Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at China Tobacco International (HK)'s (HKG:6055) ROCE trend, we were very happy with what we saw.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on China Tobacco International (HK) is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.36 = HK$945m ÷ (HK$6.3b - HK$3.6b) (Based on the trailing twelve months to June 2023).
Thus, China Tobacco International (HK) has an ROCE of 36%. That's a fantastic return and not only that, it outpaces the average of 5.3% earned by companies in a similar industry.
See our latest analysis for China Tobacco International (HK)
In the above chart we have measured China Tobacco International (HK)'s prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
We'd be pretty happy with returns on capital like China Tobacco International (HK). The company has employed 132% more capital in the last five years, and the returns on that capital have remained stable at 36%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 58% of total assets, this reported ROCE would probably be less than36% because total capital employed would be higher.The 36% ROCE could be even lower if current liabilities weren't 58% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.
The Bottom Line On China Tobacco International (HK)'s ROCE
In summary, we're delighted to see that China Tobacco International (HK) has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. Yet over the last three years the stock has declined 37%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.