Vtech Holdings (HKG:303) Will Want To Turn Around Its Return Trends

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So while Vtech Holdings (HKG:303) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. Analysts use this formula to calculate it for Vtech Holdings:

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

0.24 = US$204m ÷ (US$1.5b - US$628m) (Based on the trailing twelve months to March 2022).

Therefore, Vtech Holdings has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 6.8% earned by companies in a similar industry.

Check out the opportunities and risks within the HK Communications industry.

In the above chart we have measured Vtech Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vtech Holdings.

How Are Returns Trending?

When we looked at the ROCE trend at Vtech Holdings, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 34%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

Another thing to note, Vtech Holdings has a high ratio of current liabilities to total assets of 42%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From 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. Since the stock has declined 39% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Vtech Holdings, we've discovered 2 warning signs that 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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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.