If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. With that in mind, the ROCE of COWAY (KRX:021240) looks attractive right now, so lets see what the trend of returns can tell us.
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. To calculate this metric for COWAY, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.33 = ₩521b ÷ (₩3.1t - ₩1.5t) (Based on the trailing twelve months to September 2020).
So, COWAY has an ROCE of 33%. That's a fantastic return and not only that, it outpaces the average of 7.8% earned by companies in a similar industry.
Check out our latest analysis for COWAY
Above you can see how the current ROCE for COWAY compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering COWAY here for free.
What Can We Tell From COWAY's ROCE Trend?
In terms of COWAY's history of ROCE, it's quite impressive. Over the past five years, ROCE has remained relatively flat at around 33% and the business has deployed 29% more capital into its operations. Now considering ROCE is an attractive 33%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.
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 48% of total assets, this reported ROCE would probably be less than33% because total capital employed would be higher.The 33% ROCE could be even lower if current liabilities weren't 48% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.
What We Can Learn From COWAY's ROCE
In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. Yet over the last five years the stock has declined 12%, 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 about the risks facing COWAY, we've discovered 1 warning sign that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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About KOSE:A021240
COWAY
Engages in the production and sale of environmental home appliances in South Korea and internationally.
Solid track record with excellent balance sheet.
