What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Kangda International Environmental (HKG:6136) and its ROCE trend, we weren't exactly thrilled.
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 Kangda International Environmental, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.082 = CN¥1.1b ÷ (CN¥18b - CN¥4.6b) (Based on the trailing twelve months to December 2020).
Therefore, Kangda International Environmental has an ROCE of 8.2%. In absolute terms, that's a low return but it's around the Water Utilities industry average of 7.4%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Kangda International Environmental's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Kangda International Environmental, check out these free graphs here.
So How Is Kangda International Environmental's ROCE Trending?
There are better returns on capital out there than what we're seeing at Kangda International Environmental. The company has consistently earned 8.2% for the last five years, and the capital employed within the business has risen 89% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line
Long story short, while Kangda International Environmental has been reinvesting its capital, the returns that it's generating haven't increased. And in the last five years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
One more thing to note, we've identified 1 warning sign with Kangda International Environmental and understanding it should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
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