What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Although, when we looked at China Isotope & Radiation (HKG:1763), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for China Isotope & Radiation:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = CN¥508m ÷ (CN¥8.8b - CN¥2.7b) (Based on the trailing twelve months to June 2020).
Thus, China Isotope & Radiation has an ROCE of 8.3%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 10%.
In the above chart we have measured China Isotope & Radiation's 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 Isotope & Radiation.
So How Is China Isotope & Radiation's ROCE Trending?
On the surface, the trend of ROCE at China Isotope & Radiation doesn't inspire confidence. Around four years ago the returns on capital were 29%, but since then they've fallen to 8.3%. However it looks like China Isotope & Radiation might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, China Isotope & Radiation has decreased its current liabilities to 30% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
In summary, China Isotope & Radiation is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 21% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you'd like to know about the risks facing China Isotope & Radiation, we've discovered 2 warning signs that you should be aware of.
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