Returns On Capital Are Showing Encouraging Signs At Kunming Dianchi Water Treatment (HKG:3768)

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Kunming Dianchi Water Treatment (HKG:3768) and its trend of ROCE, we really liked what we saw.

Understanding 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. To calculate this metric for Kunming Dianchi Water Treatment, this is the formula:

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

0.11 = CN¥788m ÷ (CN¥12b - CN¥5.1b) (Based on the trailing twelve months to June 2023).

So, Kunming Dianchi Water Treatment has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 6.0% generated by the Water Utilities industry.

View our latest analysis for Kunming Dianchi Water Treatment

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Kunming Dianchi Water Treatment's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

Kunming Dianchi Water Treatment is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 25%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 42% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line On Kunming Dianchi Water Treatment's ROCE

All in all, it's terrific to see that Kunming Dianchi Water Treatment is reaping the rewards from prior investments and is growing its capital base. Given the stock has declined 60% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Kunming Dianchi Water Treatment (of which 2 don't sit too well with us!) that you should know about.

While Kunming Dianchi Water Treatment 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. 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.