There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Hengxin Technology (HKG:1085) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Hengxin Technology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.041 = CN¥73m ÷ (CN¥2.5b - CN¥678m) (Based on the trailing twelve months to December 2021).
So, Hengxin Technology has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 7.6%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hengxin Technology's ROCE against it's prior returns. If you're interested in investigating Hengxin Technology's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of Hengxin Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 4.1% from 8.1% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 27%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
Our Take On Hengxin Technology's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hengxin Technology. And long term investors must be optimistic going forward because the stock has returned a huge 112% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
On a separate note, we've found 2 warning signs for Hengxin Technology you'll probably want to know about.
While Hengxin Technology 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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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.