If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at L.K. Technology Holdings (HKG:558) and its trend of ROCE, we really liked 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. Analysts use this formula to calculate it for L.K. Technology Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = HK$604m ÷ (HK$8.7b - HK$4.4b) (Based on the trailing twelve months to September 2023).
Thus, L.K. Technology Holdings has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 7.4% it's much better.
Above you can see how the current ROCE for L.K. Technology Holdings 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 L.K. Technology Holdings here for free.
The Trend Of ROCE
L.K. Technology Holdings is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 14%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 62%. So we're very much inspired by what we're seeing at L.K. Technology Holdings thanks to its ability to profitably reinvest capital.
Another thing to note, L.K. Technology Holdings has a high ratio of current liabilities to total assets of 51%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line
In summary, it's great to see that L.K. Technology Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a staggering 376% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
While L.K. Technology Holdings looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether 558 is currently trading for a fair price.
While L.K. Technology Holdings 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.