The Return Trends At Emperor Watch & Jewellery (HKG:887) Look Promising

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Emperor Watch & Jewellery's (HKG:887) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

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 Emperor Watch & Jewellery:

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

0.015 = HK$74m ÷ (HK$5.8b - HK$1.0b) (Based on the trailing twelve months to December 2020).

Thus, Emperor Watch & Jewellery has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 11%.

View our latest analysis for Emperor Watch & Jewellery

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 Emperor Watch & Jewellery's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We're delighted to see that Emperor Watch & Jewellery is reaping rewards from its investments and has now 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 1.6%, which is always encouraging. While returns have increased, the amount of capital employed by Emperor Watch & Jewellery has remained flat over the period. 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. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

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 18% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

Our Take On Emperor Watch & Jewellery's ROCE

As discussed above, Emperor Watch & Jewellery appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Given the stock has declined 21% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing to note, we've identified 2 warning signs with Emperor Watch & Jewellery and understanding them should be part of your investment process.

While Emperor Watch & Jewellery may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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