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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Home Control International (HKG:1747) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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 Home Control International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$6.0m ÷ (US$80m - US$44m) (Based on the trailing twelve months to December 2020).
So, Home Control International has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 12% generated by the Consumer Durables industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Home Control International's ROCE against it's prior returns. If you'd like to look at how Home Control International has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
Things have been pretty stable at Home Control International, with its capital employed and returns on that capital staying somewhat the same for the last four years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Home Control International to be a multi-bagger going forward.
Another thing to note, Home Control International has a high ratio of current liabilities to total assets of 54%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Home Control International's ROCE
In a nutshell, Home Control International has been trudging along with the same returns from the same amount of capital over the last four years. Although the market must be expecting these trends to improve because the stock has gained 53% 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.
Home Control International does have some risks, we noticed 4 warning signs (and 2 which make us uncomfortable) we think you should know about.
While Home Control International 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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