Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Digital China Holdings (HKG:861) and its trend of ROCE, we really liked what we saw.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Digital China Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.049 = HK$919m ÷ (HK$30b - HK$11b) (Based on the trailing twelve months to December 2021).
Thus, Digital China Holdings has an ROCE of 4.9%. In absolute terms, that's a low return and it also under-performs the IT industry average of 7.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Digital China Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Digital China Holdings, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 4.9%. The amount of capital employed has increased too, by 41%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
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 Digital China Holdings has. Given the stock has declined 38% 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, we've spotted 3 warning signs facing Digital China Holdings that you might find interesting.
While Digital China Holdings 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.