Watts International Maritime's (HKG:2258) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Watts International Maritime (HKG:2258) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 Watts International Maritime, this is the formula:

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

0.048 = CN¥47m ÷ (CN¥3.4b - CN¥2.5b) (Based on the trailing twelve months to December 2022).

So, Watts International Maritime has an ROCE of 4.8%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.9%.

View our latest analysis for Watts International Maritime

Historical performance is a great place to start when researching a stock so above you can see the gauge for Watts International Maritime's ROCE against it's prior returns. If you're interested in investigating Watts International Maritime's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Watts International Maritime's ROCE Trending?

In terms of Watts International Maritime's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.8% from 15% five years ago. However it looks like Watts International Maritime 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Watts International Maritime's current liabilities have increased over the last five years to 72% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From Watts International Maritime's ROCE

Bringing it all together, while we're somewhat encouraged by Watts International Maritime's reinvestment in its own business, we're aware that returns are shrinking. Moreover, since the stock has crumbled 70% over the last three years, it appears investors are expecting the worst. Therefore based on the analysis done in this article, we don't think Watts International Maritime has the makings of a multi-bagger.

One final note, you should learn about the 4 warning signs we've spotted with Watts International Maritime (including 1 which shouldn't be ignored) .

While Watts International Maritime 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.