Slowing Rates Of Return At Want Want China Holdings (HKG:151) Leave Little Room For Excitement

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, while the ROCE is currently high for Want Want China Holdings (HKG:151), we aren't jumping out of our chairs because returns are decreasing.

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. To calculate this metric for Want Want China Holdings, this is the formula:

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

0.30 = CN¥5.3b ÷ (CN¥30b - CN¥12b) (Based on the trailing twelve months to September 2020).

So, Want Want China Holdings has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

See our latest analysis for Want Want China Holdings

In the above chart we have measured Want Want China Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

Over the past five years, Want Want China Holdings' ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So it may not be a multi-bagger in the making, but given the decent 30% return on capital, it'd be difficult to find fault with the business's current operations. That being the case, it makes sense that Want Want China Holdings has been paying out 86% of its earnings to its shareholders. These mature businesses typically have reliable earnings and not many places to reinvest them, so the next best option is to put the earnings into shareholders pockets.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 40% of total assets, this reported ROCE would probably be less than30% because total capital employed would be higher.The 30% ROCE could be even lower if current liabilities weren't 40% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.

What We Can Learn From Want Want China Holdings' ROCE

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. And investors may be recognizing these trends since the stock has only returned a total of 34% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

Want Want China Holdings does have some risks though, and we've spotted 2 warning signs for Want Want China Holdings that you might be interested in.

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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