If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think SK hynix (KRX:000660) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on SK hynix is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = ₩5.0t ÷ (₩71t - ₩9.1t) (Based on the trailing twelve months to December 2020).
Thus, SK hynix has an ROCE of 8.1%. On its own, that's a low figure but it's around the 8.8% average generated by the Semiconductor industry.
Above you can see how the current ROCE for SK hynix compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for SK hynix.
How Are Returns Trending?
In terms of SK hynix's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 21% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
What We Can Learn From SK hynix's ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for SK hynix. And long term investors must be optimistic going forward because the stock has returned a huge 437% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
On a separate note, we've found 2 warning signs for SK hynix you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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