What are the early trends we should look for to identify a stock that could 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. So on that note, Hung Fook Tong Group Holdings (HKG:1446) looks quite promising in regards to its trends of return on capital.
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 Hung Fook Tong Group Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = HK$66m ÷ (HK$835m - HK$396m) (Based on the trailing twelve months to December 2020).
Therefore, Hung Fook Tong Group Holdings has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 9.5% generated by the Beverage 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 Hung Fook Tong Group Holdings, check out these free graphs here.
The Trend Of ROCE
We like the trends that we're seeing from Hung Fook Tong Group Holdings. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 15%. Basically the business is earning more per dollar of capital invested and in addition to that, 45% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a separate but related note, it's important to know that Hung Fook Tong Group Holdings has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
To sum it up, Hung Fook Tong Group Holdings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And since the stock has fallen 25% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
If you'd like to know about the risks facing Hung Fook Tong Group Holdings, we've discovered 2 warning signs that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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