If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 China Railway Hi-tech Industry (SHSE:600528), we don't think it's current trends fit the mold of a multi-bagger.
Understanding Return On Capital Employed (ROCE)
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. To calculate this metric for China Railway Hi-tech Industry, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = CN¥1.9b ÷ (CN¥58b - CN¥31b) (Based on the trailing twelve months to December 2023).
So, China Railway Hi-tech Industry has an ROCE of 7.0%. Even though it's in line with the industry average of 6.7%, 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 China Railway Hi-tech Industry's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of China Railway Hi-tech Industry.
What The Trend Of ROCE Can Tell Us
In terms of China Railway Hi-tech Industry's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.0% from 8.8% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Another thing to note, China Railway Hi-tech Industry has a high ratio of current liabilities to total assets of 54%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by China Railway Hi-tech Industry's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 35% in the last five years. Therefore based on the analysis done in this article, we don't think China Railway Hi-tech Industry has the makings of a multi-bagger.
China Railway Hi-tech Industry does have some risks though, and we've spotted 1 warning sign for China Railway Hi-tech Industry that you might be interested in.
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.