Should We Be Excited About The Trends Of Returns At Vtech Holdings (HKG:303)?

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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while Vtech Holdings (HKG:303) has a high ROCE right now, lets see what we can decipher from how returns are changing.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Vtech Holdings, this is the formula:

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

0.28 = US$227m ÷ (US$1.5b - US$667m) (Based on the trailing twelve months to September 2020).

So, Vtech Holdings has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 5.0% earned by companies in a similar industry.

See our latest analysis for Vtech Holdings

In the above chart we have measured Vtech Holdings' 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 Can We Tell From Vtech Holdings' ROCE Trend?

On the surface, the trend of ROCE at Vtech Holdings doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 44%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Vtech Holdings' current liabilities are still rather high at 46% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Vtech Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Vtech Holdings' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last five years has been flat. 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.

On a final note, we've found 2 warning signs for Vtech Holdings that we think you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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