If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Vtech Holdings (HKG:303), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. The formula for this calculation on Vtech Holdings is:
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).
Therefore, 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.
View our latest analysis for Vtech Holdings
Above you can see how the current ROCE for Vtech Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vtech Holdings.
So How Is Vtech Holdings' ROCE Trending?
On the surface, the trend of ROCE at Vtech Holdings doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 44% where it was five years ago. However it looks like Vtech Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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 effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line 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. And investors may be recognizing these trends since the stock has only returned a total of 1.7% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
On a final note, we've found 1 warning sign for Vtech Holdings that we think you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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This article by Simply Wall St is general in nature. 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.
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About SEHK:303
Vtech Holdings
Designs, manufactures, and distributes electronic products in Hong Kong, North America, Europe, the Asia Pacific, and internationally.
Flawless balance sheet and good value.
