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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Skyworth Digital (SZSE:000810) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Skyworth Digital:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = CN¥472m ÷ (CN¥11b - CN¥4.9b) (Based on the trailing twelve months to December 2023).
So, Skyworth Digital has an ROCE of 7.2%. On its own that's a low return, but compared to the average of 4.3% generated by the Communications industry, it's much better.
In the above chart we have measured Skyworth Digital's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Skyworth Digital for free.
What Can We Tell From Skyworth Digital's ROCE Trend?
The returns on capital haven't changed much for Skyworth Digital in recent years. Over the past five years, ROCE has remained relatively flat at around 7.2% and the business has deployed 86% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
On a side note, Skyworth Digital has done well to reduce current liabilities to 43% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously. Although because current liabilities are still 43%, some of that risk is still prevalent.
What We Can Learn From Skyworth Digital's ROCE
In conclusion, Skyworth Digital has been investing more capital into the business, but returns on that capital haven't increased. Unsurprisingly then, the total return to shareholders over the last five years has been flat. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Like most companies, Skyworth Digital does come with some risks, and we've found 1 warning sign that you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.