Wenzhou Kangning Hospital (HKG:2120) Is Experiencing Growth In Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in Wenzhou Kangning Hospital's (HKG:2120) returns on capital, so let's have a look.

What is 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. To calculate this metric for Wenzhou Kangning Hospital, this is the formula:

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

0.078 = CN¥129m ÷ (CN¥2.2b - CN¥599m) (Based on the trailing twelve months to December 2020).

Therefore, Wenzhou Kangning Hospital has an ROCE of 7.8%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 9.8%.

See our latest analysis for Wenzhou Kangning Hospital

In the above chart we have measured Wenzhou Kangning Hospital's 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.

What Does the ROCE Trend For Wenzhou Kangning Hospital Tell Us?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. Over the last five years, returns on capital employed have risen substantially to 7.8%. 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 53%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 27% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Key Takeaway

To sum it up, Wenzhou Kangning Hospital 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 29% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

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 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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