To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Shenzhen Topway Video Communication (SZSE:002238), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What Is It?
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 Shenzhen Topway Video Communication is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = CN¥123m ÷ (CN¥4.4b - CN¥1.7b) (Based on the trailing twelve months to December 2023).
Therefore, Shenzhen Topway Video Communication has an ROCE of 4.6%. Even though it's in line with the industry average of 4.8%, it's still a low return by itself.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Topway Video Communication's ROCE against it's prior returns. If you'd like to look at how Shenzhen Topway Video Communication has performed in the past in other metrics, you can view this free graph of Shenzhen Topway Video Communication's past earnings, revenue and cash flow.
What Does the ROCE Trend For Shenzhen Topway Video Communication Tell Us?
There hasn't been much to report for Shenzhen Topway Video Communication's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Shenzhen Topway Video Communication in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 38% of total assets, this reported ROCE would probably be less than4.6% because total capital employed would be higher.The 4.6% ROCE could be even lower if current liabilities weren't 38% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
Our Take On Shenzhen Topway Video Communication's ROCE
In summary, Shenzhen Topway Video Communication isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has gained an impressive 70% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing: We've identified 2 warning signs with Shenzhen Topway Video Communication (at least 1 which can't be ignored) , and understanding them would certainly be useful.
While Shenzhen Topway Video Communication 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.