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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Estun Automation (SZSE:002747) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
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. Analysts use this formula to calculate it for Estun Automation:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = CN¥332m ÷ (CN¥9.8b - CN¥4.6b) (Based on the trailing twelve months to September 2023).
Thus, Estun Automation has an ROCE of 6.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.2%.
Above you can see how the current ROCE for Estun Automation compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Estun Automation .
How Are Returns Trending?
In terms of Estun Automation's historical ROCE trend, it doesn't exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 6.4% and the business has deployed 145% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
On a separate but related note, it's important to know that Estun Automation has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Estun Automation's ROCE
As we've seen above, Estun Automation's returns on capital haven't increased but it is reinvesting in the business. 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.
Estun Automation does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...
While Estun Automation 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.