Returns On Capital At Charmacy Pharmaceutical (HKG:2289) Paint An Interesting Picture

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Charmacy Pharmaceutical (HKG:2289) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. The formula for this calculation on Charmacy Pharmaceutical is:

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

0.11 = CN¥69m ÷ (CN¥2.4b - CN¥1.8b) (Based on the trailing twelve months to June 2020).

Therefore, Charmacy Pharmaceutical has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Healthcare industry average of 9.8%.

Check out our latest analysis for Charmacy Pharmaceutical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Charmacy Pharmaceutical's ROCE against it's prior returns. If you're interested in investigating Charmacy Pharmaceutical's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Charmacy Pharmaceutical, we didn't gain much confidence. To be more specific, ROCE has fallen from 27% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Charmacy Pharmaceutical has decreased its current liabilities to 73% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 73% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Charmacy Pharmaceutical's ROCE

To conclude, we've found that Charmacy Pharmaceutical is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 8.9% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you'd like to know more about Charmacy Pharmaceutical, we've spotted 5 warning signs, and 2 of them can't be ignored.

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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