Is Changhong Jiahua Holdings (HKG:3991) A Compounding Machine?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Changhong Jiahua Holdings (HKG:3991) looks attractive right now, so lets see what the trend of returns can tell us.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Changhong Jiahua Holdings is:

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

0.23 = HK$434m ÷ (HK$6.8b - HK$4.9b) (Based on the trailing twelve months to June 2020).

So, Changhong Jiahua Holdings has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Electronic industry average of 7.7%.

Check out our latest analysis for Changhong Jiahua Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Changhong Jiahua Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Changhong Jiahua Holdings, check out these free graphs here.

What Can We Tell From Changhong Jiahua Holdings' ROCE Trend?

We'd be pretty happy with returns on capital like Changhong Jiahua Holdings. The company has employed 40% more capital in the last five years, and the returns on that capital have remained stable at 23%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a separate but related note, it's important to know that Changhong Jiahua Holdings has a current liabilities to total assets ratio of 72%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Changhong Jiahua Holdings' ROCE

In short, we'd argue Changhong Jiahua Holdings has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Yet over the last five years the stock has declined 29%, so the decline might provide an opening. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

If you want to know some of the risks facing Changhong Jiahua Holdings we've found 4 warning signs (2 are concerning!) that you should be aware of before investing here.

Changhong Jiahua Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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