Here's What To Make Of China Leon Inspection Holding's (HKG:1586) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at China Leon Inspection Holding (HKG:1586), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding 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. Analysts use this formula to calculate it for China Leon Inspection Holding:

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

0.23 = CN¥64m ÷ (CN¥448m - CN¥169m) (Based on the trailing twelve months to June 2020).

So, China Leon Inspection Holding has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Energy Services industry average of 11%.

See our latest analysis for China Leon Inspection Holding

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Leon Inspection Holding's ROCE against it's prior returns. If you're interested in investigating China Leon Inspection Holding's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For China Leon Inspection Holding Tell Us?

When we looked at the ROCE trend at China Leon Inspection Holding, we didn't gain much confidence. Historically returns on capital were even higher at 43%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that China Leon Inspection Holding is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 11% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing: We've identified 3 warning signs with China Leon Inspection Holding (at least 1 which is significant) , and understanding these would certainly be useful.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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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