If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Looking at Tsaker Chemical Group (HKG:1986), it does have a high ROCE right now, but lets see how returns are trending.
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. The formula for this calculation on Tsaker Chemical Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = CN¥436m ÷ (CN¥2.4b - CN¥649m) (Based on the trailing twelve months to June 2020).
Thus, Tsaker Chemical Group has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Chemicals industry average of 11%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Tsaker Chemical Group's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Tsaker Chemical Group, check out these free graphs here.
So How Is Tsaker Chemical Group's ROCE Trending?
In terms of Tsaker Chemical Group's historical ROCE movements, the trend isn't fantastic. Historically returns on capital were even higher at 59%, but they have dropped over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, Tsaker Chemical Group has done well to pay down its current liabilities to 27% 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.
Our Take On Tsaker Chemical Group's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Tsaker Chemical Group have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 18% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Like most companies, Tsaker Chemical Group does come with some risks, and we've found 2 warning signs that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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