What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at 7Road Holdings (HKG:797), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on 7Road Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.065 = CN¥147m ÷ (CN¥2.6b - CN¥371m) (Based on the trailing twelve months to June 2023).
Therefore, 7Road Holdings has an ROCE of 6.5%. On its own, that's a low figure but it's around the 6.6% average generated by the Entertainment industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for 7Road Holdings' ROCE against it's prior returns. If you'd like to look at how 7Road Holdings has performed in the past in other metrics, you can view this free graph of 7Road Holdings' past earnings, revenue and cash flow.
What Can We Tell From 7Road Holdings' ROCE Trend?
On the surface, the trend of ROCE at 7Road Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.5% from 31% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, 7Road Holdings has decreased its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. 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.
The Bottom Line On 7Road Holdings' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that 7Road Holdings is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 67% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
7Road Holdings does have some risks though, and we've spotted 1 warning sign for 7Road Holdings that you might be interested in.
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.