Newborn Town (HKG:9911) Shareholders Will Want The ROCE Trajectory To Continue

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Newborn Town (HKG:9911) and its trend of ROCE, we really liked what we saw.

What is 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 Newborn Town, this is the formula:

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

0.19 = CN¥164m ÷ (CN¥1.3b - CN¥409m) (Based on the trailing twelve months to December 2020).

So, Newborn Town has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Software industry average of 5.2% it's much better.

Check out our latest analysis for Newborn Town

In the above chart we have measured Newborn Town's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

The trends we've noticed at Newborn Town are quite reassuring. The data shows that returns on capital have increased substantially over the last four years to 19%. 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 98%. So we're very much inspired by what we're seeing at Newborn Town thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 32% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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.

The Bottom Line

To sum it up, Newborn Town has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 228% total return over the last year tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you'd like to know about the risks facing Newborn Town, we've discovered 1 warning sign that you should be aware of.

While Newborn Town 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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