Returns On Capital Signal Tricky Times Ahead For Launch Tech (HKG:2488)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Having said that, from a first glance at Launch Tech (HKG:2488) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Launch Tech:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.074 = CN¥89m ÷ (CN¥1.7b - CN¥502m) (Based on the trailing twelve months to June 2022).

Thus, Launch Tech has an ROCE of 7.4%. In absolute terms, that's a low return, but it's much better than the Auto Components industry average of 3.9%.

Our analysis indicates that 2488 is potentially undervalued!

Historical performance is a great place to start when researching a stock so above you can see the gauge for Launch Tech's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Launch Tech, check out these free graphs here.

What Can We Tell From Launch Tech's ROCE Trend?

In terms of Launch Tech's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 11%, but since then they've fallen to 7.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

On a related note, Launch Tech has decreased its current liabilities to 29% 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.

The Bottom Line On Launch Tech's ROCE

In summary, Launch Tech is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 68% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a separate note, we've found 1 warning sign for Launch Tech you'll probably want to know about.

While Launch Tech 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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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.