If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in China Sanjiang Fine Chemicals’ (HKG:2198) returns on capital, so let’s have a look.
What is 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. To calculate this metric for China Sanjiang Fine Chemicals, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = CN¥1.0b ÷ (CN¥13b – CN¥7.3b) (Based on the trailing twelve months to June 2020).
So, China Sanjiang Fine Chemicals has an ROCE of 19%. On its own, that’s a standard return, however it’s much better than the 11% generated by the Chemicals industry.
In the above chart we have measured China Sanjiang Fine Chemicals’ 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 report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
We’re delighted to see that China Sanjiang Fine Chemicals is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it’s now turned things around and is earning 19% on its capital. On top of that, what’s interesting is that the amount of capital being employed has remained steady, so the business hasn’t needed to put any additional money to work to generate these higher returns. So while we’re happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you’re looking for high growth, you’ll want to see a business’s capital employed also increasing.Another thing to note, China Sanjiang Fine Chemicals has a high ratio of current liabilities to total assets of 57%. 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.
The Key Takeaway
As discussed above, China Sanjiang Fine Chemicals appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with the stock having performed exceptionally well over the last five years, these trends are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you want to continue researching China Sanjiang Fine Chemicals, you might be interested to know about the 3 warning signs that our analysis has discovered.
While China Sanjiang Fine Chemicals isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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