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. Having said that, from a first glance at Gree Electric Appliances of Zhuhai (SZSE:000651) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
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 Gree Electric Appliances of Zhuhai is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = CN¥24b ÷ (CN¥386b - CN¥221b) (Based on the trailing twelve months to September 2023).
Thus, Gree Electric Appliances of Zhuhai has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Consumer Durables industry average of 7.9% it's much better.
Above you can see how the current ROCE for Gree Electric Appliances of Zhuhai 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 Gree Electric Appliances of Zhuhai.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Gree Electric Appliances of Zhuhai doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 34% five years ago. 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 may take some time before the company starts to see any change in earnings from these investments.
On a separate but related note, it's important to know that Gree Electric Appliances of Zhuhai has a current liabilities to total assets ratio of 57%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Gree Electric Appliances of Zhuhai's ROCE
In summary, Gree Electric Appliances of Zhuhai is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 12% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
One more thing to note, we've identified 1 warning sign with Gree Electric Appliances of Zhuhai 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.