What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Expert Systems Holdings (HKG:8319) and its ROCE trend, we weren't exactly thrilled.
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. To calculate this metric for Expert Systems Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = HK$15m ÷ (HK$228m - HK$112m) (Based on the trailing twelve months to September 2020).
Therefore, Expert Systems Holdings has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the IT industry average of 8.6% 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 Expert Systems Holdings, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Expert Systems Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 26% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.On a side note, Expert Systems Holdings' current liabilities are still rather high at 49% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Expert Systems Holdings' ROCE
In summary, Expert Systems Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 33% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
If you'd like to know about the risks facing Expert Systems Holdings, we've discovered 2 warning signs that you should be aware of.
While Expert Systems 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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