To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. So when we looked at Meituan (HKG:3690) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Meituan:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.013 = CN¥1.4b ÷ (CN¥150b - CN¥46b) (Based on the trailing twelve months to September 2020).
Therefore, Meituan has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Online Retail industry average of 3.7%.
In the above chart we have measured Meituan's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Meituan.
What Can We Tell From Meituan's ROCE Trend?
The fact that Meituan is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 1.3% on its capital. Not only that, but the company is utilizing 177% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
The Key Takeaway
To the delight of most shareholders, Meituan has now broken into profitability. And with the stock having performed exceptionally well over the last year, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Meituan does have some risks though, and we've spotted 1 warning sign for Meituan that you might be interested in.
While Meituan 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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This article by Simply Wall St is general in nature. 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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