What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Lever Style (HKG:1346), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
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 Lever Style:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$4.5m ÷ (US$62m - US$26m) (Based on the trailing twelve months to June 2021).
Therefore, Lever Style has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 7.6% generated by the Luxury industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Lever Style's ROCE against it's prior returns. If you'd like to look at how Lever Style has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Lever Style Tell Us?
When we looked at the ROCE trend at Lever Style, we didn't gain much confidence. To be more specific, ROCE has fallen from 38% over the last four years. However it looks like Lever Style might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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, Lever Style has decreased its current liabilities to 42% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.
The Key Takeaway
To conclude, we've found that Lever Style is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 8.6% over the last year. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Lever Style does have some risks, we noticed 4 warning signs (and 2 which don't sit too well with us) we think you should know about.
While Lever Style 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.