If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Lee & Man Chemical's (HKG:746) returns on capital, so let's have a look.
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 Lee & Man Chemical is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = HK$1.0b ÷ (HK$7.2b - HK$1.5b) (Based on the trailing twelve months to June 2021).
So, Lee & Man Chemical has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 12% generated by the Chemicals 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 Lee & Man Chemical's past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Lee & Man Chemical's ROCE Trending?
Lee & Man Chemical is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 18%. Basically the business is earning more per dollar of capital invested and in addition to that, 48% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line On Lee & Man Chemical's ROCE
To sum it up, Lee & Man Chemical has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 381% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing, we've spotted 2 warning signs facing Lee & Man Chemical that you might find interesting.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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