Be Wary Of China Literature (HKG:772) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at China Literature (HKG:772), it didn't seem to tick all of these boxes.

What Is 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 Literature is:

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

0.038 = CN¥733m ÷ (CN¥22b - CN¥3.2b) (Based on the trailing twelve months to June 2023).

Thus, China Literature has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Media industry average of 8.6%.

Check out our latest analysis for China Literature

Above you can see how the current ROCE for China Literature compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Literature here for free.

What Does the ROCE Trend For China Literature Tell Us?

On the surface, the trend of ROCE at China Literature doesn't inspire confidence. To be more specific, ROCE has fallen from 5.1% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

What We Can Learn From China Literature's ROCE

In summary, we're somewhat concerned by China Literature's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 34% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing China Literature, we've discovered 1 warning sign that you should be aware of.

While China Literature may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.