There Are Reasons To Feel Uneasy About Clifford Modern Living Holdings' (HKG:3686) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So while Clifford Modern Living Holdings (HKG:3686) has a high ROCE right now, lets see what we can decipher from how returns are changing.

What is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Clifford Modern Living Holdings is:

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

0.22 = CN¥118m ÷ (CN¥694m - CN¥152m) (Based on the trailing twelve months to December 2020).

Therefore, Clifford Modern Living Holdings has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Industrials industry average of 3.0%.

View our latest analysis for Clifford Modern Living Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Clifford Modern Living Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Clifford Modern Living Holdings, check out these free graphs here.

What Does the ROCE Trend For Clifford Modern Living Holdings Tell Us?

In terms of Clifford Modern Living Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 55% where it was five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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, Clifford Modern Living Holdings has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Clifford Modern Living Holdings' reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 12% in the last three years. 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.

One more thing: We've identified 3 warning signs with Clifford Modern Living Holdings (at least 1 which can't be ignored) , and understanding these would certainly be useful.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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