Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Cowealth Medical ChinaLtd (SHSE:603122) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Cowealth Medical ChinaLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = CN¥65m ÷ (CN¥1.5b - CN¥286m) (Based on the trailing twelve months to December 2023).
Thus, Cowealth Medical ChinaLtd has an ROCE of 5.5%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 10%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Cowealth Medical ChinaLtd's ROCE against it's prior returns. If you're interested in investigating Cowealth Medical ChinaLtd's past further, check out this free graph covering Cowealth Medical ChinaLtd's past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Cowealth Medical ChinaLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.5% from 20% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, Cowealth Medical ChinaLtd has decreased its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Cowealth Medical ChinaLtd's ROCE
We're a bit apprehensive about Cowealth Medical ChinaLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 43% over the last year, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Cowealth Medical ChinaLtd (of which 1 shouldn't be ignored!) that you should know about.
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.