Investors Shouldn't Overlook China Tobacco International (HK)'s (HKG:6055) Impressive Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Speaking of which, we noticed some great changes in China Tobacco International (HK)'s (HKG:6055) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for China Tobacco International (HK), this is the formula:

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).

Therefore, 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 8.3%.

See our latest analysis for China Tobacco International (HK)

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).

The Trend Of ROCE

China Tobacco International (HK)'s ROCE growth is quite impressive. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 34% in that same time. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. 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

In summary, we're delighted to see that China Tobacco International (HK) has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And since the stock has fallen 27% 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.

On a separate note, we've found 1 warning sign for China Tobacco International (HK) you'll probably want to know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.