What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. With that in mind, we've noticed some promising trends at Tongcheng Travel Holdings (HKG:780) so let's look a bit deeper.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for Tongcheng Travel Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = CN¥793m ÷ (CN¥20b - CN¥4.6b) (Based on the trailing twelve months to June 2021).
Thus, Tongcheng Travel Holdings has an ROCE of 5.1%. In absolute terms, that's a low return, but it's much better than the Hospitality industry average of 2.0%.
In the above chart we have measured Tongcheng Travel Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Tongcheng Travel Holdings here for free.
What Does the ROCE Trend For Tongcheng Travel Holdings Tell Us?
The fact that Tongcheng Travel Holdings is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 5.1% on its capital. In addition to that, Tongcheng Travel Holdings is employing 1,515% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.
One more thing to note, Tongcheng Travel Holdings has decreased current liabilities to 23% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
The Bottom Line
Overall, Tongcheng Travel Holdings gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Given the stock has declined 17% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
On a final note, we've found 1 warning sign for Tongcheng Travel Holdings that we think you should be aware of.
While Tongcheng Travel Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.