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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Hengtong Optic-Electric (SHSE:600487) 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. Analysts use this formula to calculate it for Hengtong Optic-Electric:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = CN¥3.0b ÷ (CN¥63b - CN¥28b) (Based on the trailing twelve months to March 2024).
So, Hengtong Optic-Electric has an ROCE of 8.3%. In absolute terms, that's a low return, but it's much better than the Communications industry average of 4.8%.
In the above chart we have measured Hengtong Optic-Electric's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hengtong Optic-Electric .
What The Trend Of ROCE Can Tell Us
In terms of Hengtong Optic-Electric's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 17%, but since then they've fallen to 8.3%. However it looks like Hengtong Optic-Electric might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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, Hengtong Optic-Electric has a high ratio of current liabilities to total assets of 44%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On Hengtong Optic-Electric's ROCE
In summary, Hengtong Optic-Electric is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 29% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Like most companies, Hengtong Optic-Electric does come with some risks, and we've found 1 warning sign that you should be aware of.
While Hengtong Optic-Electric 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.