What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So, when we ran our eye over Perfect Medical Health Management's (HKG:1830) trend of ROCE, we really liked what we saw.
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. To calculate this metric for Perfect Medical Health Management, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.33 = HK$303m ÷ (HK$1.5b - HK$559m) (Based on the trailing twelve months to March 2021).
Therefore, Perfect Medical Health Management has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 7.5% earned by companies in a similar industry.
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 Perfect Medical Health Management, check out these free graphs here.
What Does the ROCE Trend For Perfect Medical Health Management Tell Us?
It's hard not to be impressed by Perfect Medical Health Management's returns on capital. The company has employed 89% more capital in the last five years, and the returns on that capital have remained stable at 33%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
In summary, we're delighted to see that Perfect Medical Health Management has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And the stock has done incredibly well with a 2,049% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
One more thing to note, we've identified 3 warning signs with Perfect Medical Health Management and understanding them should be part of your investment process.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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