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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. So when we looked at Oriental Watch Holdings (HKG:398) and its trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Oriental Watch Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = HK$186m ÷ (HK$2.8b - HK$329m) (Based on the trailing twelve months to September 2020).
Thus, Oriental Watch Holdings has an ROCE of 7.7%. In absolute terms, that's a low return but it's around the Specialty Retail industry average of 9.2%.
In the above chart we have measured Oriental Watch Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Oriental Watch Holdings here for free.
So How Is Oriental Watch Holdings' ROCE Trending?
Shareholders will be relieved that Oriental Watch Holdings has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 7.7%, which is always encouraging. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. Because in the end, a business can only get so efficient.
What We Can Learn From Oriental Watch Holdings' ROCE
As discussed above, Oriental Watch Holdings appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a staggering 421% to shareholders over the last five years, it looks like investors are recognizing these changes. 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.
Oriental Watch Holdings does have some risks though, and we've spotted 2 warning signs for Oriental Watch Holdings that you might be interested in.
While Oriental Watch 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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