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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating China Resources Medical Holdings (HKG:1515), we don't think it's current trends fit the mold of a multi-bagger.
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. Analysts use this formula to calculate it for China Resources Medical Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.061 = CN¥409m ÷ (CN¥8.6b - CN¥1.9b) (Based on the trailing twelve months to June 2020).
Thus, China Resources Medical Holdings has an ROCE of 6.1%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 8.3%.
In the above chart we have measured China Resources Medical Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Resources Medical Holdings.
The Trend Of ROCE
On the surface, the trend of ROCE at China Resources Medical Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.1% from 12% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a side note, China Resources Medical Holdings' current liabilities have increased over the last five years to 22% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by China Resources Medical Holdings' reinvestment in its own business, we're aware that returns are shrinking. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
On a separate note, we've found 1 warning sign for China Resources Medical Holdings you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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