The Returns At Design Capital (HKG:1545) Provide Us With Signs Of What's To Come

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Having said that, from a first glance at Design Capital (HKG:1545) 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)

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 Design Capital, this is the formula:

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

0.14 = S$9.5m ÷ (S$98m - S$28m) (Based on the trailing twelve months to June 2020).

So, Design Capital has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 5.4% it's much better.

Check out our latest analysis for Design Capital

Historical performance is a great place to start when researching a stock so above you can see the gauge for Design Capital's ROCE against it's prior returns. If you'd like to look at how Design Capital has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Design Capital's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 31% over the last three years. However it looks like Design Capital 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.

On a related note, Design Capital has decreased its current liabilities to 28% 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.

Our Take On Design Capital's ROCE

In summary, Design Capital is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last year has been flat. 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 final note, we've found 3 warning signs for Design Capital that we think you should be aware of.

While Design Capital 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. 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.
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