Investors Will Want ELL Environmental Holdings' (HKG:1395) Growth In ROCE To Persist

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. So when we looked at ELL Environmental Holdings (HKG:1395) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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 ELL Environmental Holdings is:

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

0.071 = HK$28m ÷ (HK$544m - HK$149m) (Based on the trailing twelve months to June 2022).

Thus, ELL Environmental Holdings has an ROCE of 7.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.5%.

Our analysis indicates that 1395 is potentially overvalued!

Historical performance is a great place to start when researching a stock so above you can see the gauge for ELL Environmental Holdings' ROCE against it's prior returns. If you'd like to look at how ELL Environmental Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

It's great to see that ELL Environmental Holdings has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 7.1% which is no doubt a relief for some early shareholders. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 36%. This could potentially mean that the company is selling some of its assets.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 27% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

Our Take On ELL Environmental Holdings' ROCE

In the end, ELL Environmental Holdings has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 33% over the last five years, there might be an opportunity here. With that in mind, we believe the promising trends warrant this stock for further investigation.

ELL Environmental Holdings does have some risks though, and we've spotted 1 warning sign for ELL Environmental Holdings that you might be interested in.

While ELL Environmental Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.