To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Fenbi (HKG:2469) and its trend of ROCE, we really liked what we saw.
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 Fenbi is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = CN¥138m ÷ (CN¥2.2b - CN¥799m) (Based on the trailing twelve months to June 2023).
Therefore, Fenbi has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Services industry average of 11%.
Above you can see how the current ROCE for Fenbi compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Fenbi here for free.
How Are Returns Trending?
The fact that Fenbi is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses three years ago, but now it's earning 10% which is a sight for sore eyes. In addition to that, Fenbi is employing 1,171% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 37%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
The Bottom Line
In summary, it's great to see that Fenbi has managed to break into profitability and is continuing to reinvest in its business. Astute investors may have an opportunity here because the stock has declined 70% in the last year. So researching this company further and determining whether or not these trends will continue seems justified.
One more thing to note, we've identified 2 warning signs with Fenbi and understanding them should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.