Be Wary Of Sanbase (HKG:8501) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. However, after briefly looking over the numbers, we don't think Sanbase (HKG:8501) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. Analysts use this formula to calculate it for Sanbase:

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

0.057 = HK$8.3m ÷ (HK$334m - HK$189m) (Based on the trailing twelve months to June 2023).

So, Sanbase has an ROCE of 5.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.5%.

View our latest analysis for Sanbase

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're interested in investigating Sanbase's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Sanbase, we didn't gain much confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 5.7%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Sanbase's current liabilities have increased over the last five years to 57% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 5.7%. 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.

The Bottom Line On Sanbase's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Sanbase is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 67% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Sanbase does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.