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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. So when we looked at China Sunshine Paper Holdings (HKG:2002) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on China Sunshine Paper Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = CN¥705m ÷ (CN¥9.4b - CN¥5.2b) (Based on the trailing twelve months to December 2020).
Therefore, China Sunshine Paper Holdings has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 13% generated by the Packaging industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating China Sunshine Paper Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
China Sunshine Paper Holdings is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 17%. 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 73%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 55%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
The Bottom Line
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what China Sunshine Paper Holdings has. And a remarkable 115% total return over the last five years tells us that investors are expecting more good things to come in the future. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing to note, we've identified 2 warning signs with China Sunshine Paper Holdings and understanding them should be part of your investment process.
While China Sunshine Paper Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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China Sunshine Paper Holdings
China Sunshine Paper Holdings Company Limited, together with its subsidiaries, produces and sells paper products in the People's Republic of China and internationally.
Slightly overvalued with imperfect balance sheet.