To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating Sunwoda ElectronicLtd (SZSE:300207), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Sunwoda ElectronicLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0077 = CN¥358m ÷ (CN¥79b - CN¥33b) (Based on the trailing twelve months to September 2023).
Thus, Sunwoda ElectronicLtd has an ROCE of 0.8%. Ultimately, that's a low return and it under-performs the Electrical industry average of 6.4%.
Above you can see how the current ROCE for Sunwoda ElectronicLtd 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 Sunwoda ElectronicLtd for free.
How Are Returns Trending?
Unfortunately, the trend isn't great with ROCE falling from 13% five years ago, while capital employed has grown 602%. That being said, Sunwoda ElectronicLtd raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Sunwoda ElectronicLtd's earnings and if they change as a result from the capital raise.
On a related note, Sunwoda ElectronicLtd has decreased its current liabilities to 41% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 41% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Sunwoda ElectronicLtd's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 21% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
On a separate note, we've found 1 warning sign for Sunwoda ElectronicLtd you'll probably want to know about.
While Sunwoda ElectronicLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.