Investors Will Want Lonking Holdings' (HKG:3339) Growth In ROCE To Persist

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Lonking Holdings (HKG:3339) and its trend of ROCE, we really liked what we saw.

What is 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 Lonking Holdings, this is the formula:

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

0.13 = CN¥1.4b ÷ (CN¥19b - CN¥7.9b) (Based on the trailing twelve months to June 2021).

So, Lonking Holdings has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 10.0% generated by the Machinery industry.

View our latest analysis for Lonking Holdings

In the above chart we have measured Lonking Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Lonking Holdings' ROCE Trend?

Lonking Holdings is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 332% over the last five years. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

Our Take On Lonking Holdings' ROCE

As discussed above, Lonking Holdings appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 74% return over the last five years. In light of that, we think it's worth looking further into this stock because if Lonking Holdings can keep these trends up, it could have a bright future ahead.

Lonking Holdings does have some risks, we noticed 4 warning signs (and 2 which can't be ignored) we think you should know about.

While Lonking Holdings 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.

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.

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