What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Yau Lee Holdings (HKG:406) so let's look a bit deeper.
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. The formula for this calculation on Yau Lee Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.017 = HK$45m ÷ (HK$5.3b - HK$2.6b) (Based on the trailing twelve months to September 2020).
Thus, Yau Lee Holdings has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Construction industry average of 9.1%.
View our latest analysis for Yau Lee Holdings
Historical performance is a great place to start when researching a stock so above you can see the gauge for Yau Lee Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Yau Lee Holdings, check out these free graphs here.
What Can We Tell From Yau Lee Holdings' ROCE Trend?
Yau Lee Holdings has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 1.7% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by Yau Lee Holdings has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
On a related note, the company's ratio of current liabilities to total assets has decreased to 49%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
The Bottom Line On Yau Lee Holdings' ROCE
As discussed above, Yau Lee Holdings appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Considering the stock has delivered 19% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
Like most companies, Yau Lee Holdings does come with some risks, and we've found 3 warning signs that you should be aware of.
While Yau Lee Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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About SEHK:406
Yau Lee Holdings
An investment holding company, engages in the construction business in Hong Kong and internationally.
Proven track record with adequate balance sheet.
