There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Looking at Thelloy Development Group (HKG:1546), it does have a high ROCE right now, but lets see how returns are trending.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Thelloy Development Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = HK$28m ÷ (HK$219m - HK$96m) (Based on the trailing twelve months to March 2020).
Thus, Thelloy Development Group has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Thelloy Development Group's ROCE against it's prior returns. If you're interested in investigating Thelloy Development Group's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Thelloy Development Group Tell Us?
On the surface, the trend of ROCE at Thelloy Development Group doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 38% where it was five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.On a side note, Thelloy Development Group has done well to pay down its current liabilities to 44% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. Keep in mind 44% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line On Thelloy Development Group's ROCE
We're a bit apprehensive about Thelloy Development Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. We expect this has contributed to the stock plummeting 84% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
On a separate note, we've found 3 warning signs for Thelloy Development Group you'll probably want to know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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