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

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Ergo, when we looked at the ROCE trends at Changhong Jiahua Holdings (HKG:3991), we liked what we saw.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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%. That's a fantastic return and not only that, it outpaces the average of 7.7% earned by companies in a similar industry.

View 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.

How Are Returns Trending?

We'd be pretty happy with returns on capital like Changhong Jiahua Holdings. Over the past five years, ROCE has remained relatively flat at around 23% and the business has deployed 40% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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 19%, 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'd like to know more about Changhong Jiahua Holdings, we've spotted 4 warning signs, and 2 of them don't sit too well with us.

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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