Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. And in light of that, the trends we're seeing at Nongfu Spring's (HKG:9633) look very promising so lets take a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Nongfu Spring:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.45 = CN¥8.2b ÷ (CN¥30b - CN¥12b) (Based on the trailing twelve months to June 2021).
Thus, Nongfu Spring has an ROCE of 45%. In absolute terms that's a great return and it's even better than the Beverage industry average of 11%.
In the above chart we have measured Nongfu Spring's 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 Nongfu Spring here for free.
How Are Returns Trending?
Investors would be pleased with what's happening at Nongfu Spring. The numbers show that in the last three years, the returns generated on capital employed have grown considerably to 45%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 38%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a side note, Nongfu Spring's current liabilities are still rather high at 40% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Nongfu Spring has. Since the stock has only returned 6.0% to shareholders over the last year, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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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