To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Shenzhen International Holdings (HKG:152), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for Shenzhen International Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = HK$4.1b ÷ (HK$98b - HK$22b) (Based on the trailing twelve months to June 2020).
Thus, Shenzhen International Holdings has an ROCE of 5.4%. In absolute terms, that's a low return but it's around the Infrastructure industry average of 5.6%.
In the above chart we have measured Shenzhen International 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 Does the ROCE Trend For Shenzhen International Holdings Tell Us?
In terms of Shenzhen International Holdings' historical ROCE trend, it doesn't exactly demand attention. The company has consistently earned 5.4% for the last five years, and the capital employed within the business has risen 78% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 22% of total assets, this reported ROCE would probably be less than5.4% because total capital employed would be higher.The 5.4% ROCE could be even lower if current liabilities weren't 22% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.
As we've seen above, Shenzhen International Holdings' returns on capital haven't increased but it is reinvesting in the business. And with the stock having returned a mere 32% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
Shenzhen International Holdings does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are a bit concerning...
While Shenzhen International Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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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