To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Although, when we looked at Ruifeng Power Group (HKG:2025), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Ruifeng Power Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = CN¥47m ÷ (CN¥1.4b - CN¥428m) (Based on the trailing twelve months to December 2020).
So, Ruifeng Power Group has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 8.4%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Ruifeng Power Group, check out these free graphs here.
How Are Returns Trending?
When we looked at the ROCE trend at Ruifeng Power Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.6% from 21% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Ruifeng Power Group has decreased its current liabilities to 30% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Ruifeng Power Group's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Ruifeng Power Group is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 41% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
One more thing to note, we've identified 1 warning sign with Ruifeng Power Group and understanding this should be part of your investment process.
While Ruifeng Power Group 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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