If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So on that note, Capinfo (HKG:1075) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Capinfo:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = CN¥143m ÷ (CN¥2.5b - CN¥1.2b) (Based on the trailing twelve months to June 2021).
Thus, Capinfo has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the IT industry average of 7.2% it's much better.
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 want to delve into the historical earnings, revenue and cash flow of Capinfo, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
The trends we've noticed at Capinfo are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 33%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a separate but related note, it's important to know that Capinfo has a current liabilities to total assets ratio of 49%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Capinfo's ROCE
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Capinfo has. Astute investors may have an opportunity here because the stock has declined 44% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
One more thing, we've spotted 2 warning signs facing Capinfo that you might find interesting.
While Capinfo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.