If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Centenary United Holdings (HKG:1959), we don't think it's current trends fit the mold of a multi-bagger.
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. Analysts use this formula to calculate it for Centenary United Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.07 = CN¥26m ÷ (CN¥815m - CN¥437m) (Based on the trailing twelve months to December 2020).
Thus, Centenary United Holdings has an ROCE of 7.0%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.7%.
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 Centenary United Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Centenary United Holdings' historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 14%, but since then they've fallen to 7.0%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Centenary United Holdings has decreased its current liabilities to 54% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 54% is still pretty high, so those risks are still somewhat prevalent.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Centenary United Holdings' reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 124% return in the last year, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing: We've identified 4 warning signs with Centenary United Holdings (at least 1 which can't be ignored) , and understanding these would certainly be useful.
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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