There Are Reasons To Feel Uneasy About Xiabuxiabu Catering Management (China) Holdings' (HKG:520) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Xiabuxiabu Catering Management (China) Holdings (HKG:520), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Xiabuxiabu Catering Management (China) Holdings is:

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

0.11 = CN¥391m ÷ (CN¥5.3b - CN¥1.8b) (Based on the trailing twelve months to June 2021).

Therefore, Xiabuxiabu Catering Management (China) Holdings has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 2.4% it's much better.

See our latest analysis for Xiabuxiabu Catering Management (China) Holdings

Above you can see how the current ROCE for Xiabuxiabu Catering Management (China) Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Xiabuxiabu Catering Management (China) Holdings.

The Trend Of ROCE

In terms of Xiabuxiabu Catering Management (China) Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 11% from 18% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 11%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

Our Take On Xiabuxiabu Catering Management (China) Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Xiabuxiabu Catering Management (China) Holdings is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 25% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing to note, we've identified 1 warning sign with Xiabuxiabu Catering Management (China) Holdings and understanding it should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.

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