China Tobacco International (HK) (HKG:6055) Could Become A Multi-Bagger

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. And in light of that, the trends we're seeing at China Tobacco International (HK)'s (HKG:6055) look very promising so lets take a look.

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 China Tobacco International (HK):

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

0.25 = HK$551m ÷ (HK$6.2b - HK$4.0b) (Based on the trailing twelve months to June 2022).

So, China Tobacco International (HK) has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Retail Distributors industry average of 8.9%.

Our analysis indicates that 6055 is potentially overvalued!

In the above chart we have measured China Tobacco International (HK)'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 China Tobacco International (HK).

What The Trend Of ROCE Can Tell Us

China Tobacco International (HK)'s ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 34% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 65% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From China Tobacco International (HK)'s ROCE

As discussed above, China Tobacco International (HK) appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And since the stock has fallen 49% over the last three years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing, we've spotted 1 warning sign facing China Tobacco International (HK) that you might find interesting.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.