If you're looking for a multi-bagger, there's a few things to keep an eye out 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Capital Environment Holdings (HKG:3989) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Capital Environment Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.093 = CN¥1.5b ÷ (CN¥25b - CN¥8.3b) (Based on the trailing twelve months to June 2021).
So, Capital Environment Holdings has an ROCE of 9.3%. Even though it's in line with the industry average of 9.1%, it's still a low return by itself.
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 Capital Environment Holdings, check out these free graphs here.
So How Is Capital Environment Holdings' ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 17% five years ago, while the business's capital employed increased by 458%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Capital Environment Holdings might not have received a full period of earnings contribution from it.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 33%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 9.3%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
While returns have fallen for Capital Environment Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 46% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
One more thing: We've identified 3 warning signs with Capital Environment Holdings (at least 1 which is a bit concerning) , and understanding them would certainly be useful.
While Capital Environment 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.
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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.