Returns Are Gaining Momentum At Cosmos Machinery Enterprises (HKG:118)

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So when we looked at Cosmos Machinery Enterprises (HKG:118) and its trend of ROCE, we really liked what we saw.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Cosmos Machinery Enterprises is:

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

0.062 = HK$103m ÷ (HK$2.8b - HK$1.1b) (Based on the trailing twelve months to June 2022).

So, Cosmos Machinery Enterprises has an ROCE of 6.2%. On its own, that's a low figure but it's around the 6.9% average generated by the Machinery industry.

Our analysis indicates that 118 is potentially undervalued!

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

So How Is Cosmos Machinery Enterprises' ROCE Trending?

The fact that Cosmos Machinery Enterprises is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 6.2% on its capital. And unsurprisingly, like most companies trying to break into the black, Cosmos Machinery Enterprises is utilizing 30% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 40%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Cosmos Machinery Enterprises has grown its returns without a reliance on increasing their current liabilities, which we're very happy with. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.

What We Can Learn From Cosmos Machinery Enterprises' ROCE

Long story short, we're delighted to see that Cosmos Machinery Enterprises' reinvestment activities have paid off and the company is now profitable. Given the stock has declined 36% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we've found 2 warning signs for Cosmos Machinery Enterprises that we think you should be aware of.

While Cosmos Machinery Enterprises 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.