If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at China Glass Holdings (HKG:3300) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for China Glass Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = CN¥47m ÷ (CN¥7.2b - CN¥3.5b) (Based on the trailing twelve months to December 2019).
Therefore, China Glass Holdings has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Building industry average of 9.3%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of China Glass Holdings, check out these free graphs here.
So How Is China Glass Holdings' ROCE Trending?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 79% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.Another thing to note, China Glass Holdings has a high ratio of current liabilities to total assets of 49%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Key Takeaway
In summary, we're delighted to see that China Glass Holdings has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Given the stock has declined 64% in the last five years, there could be a chance of a good investment here if the valuation makes sense. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing: We've identified 3 warning signs with China Glass Holdings (at least 1 which is a bit concerning) , and understanding these would certainly be useful.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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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