If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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 Meiloon Industrial (TPE:2477) and its trend of ROCE, we really liked what we saw.
What is 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. To calculate this metric for Meiloon Industrial, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.034 = NT$170m ÷ (NT$6.7b - NT$1.6b) (Based on the trailing twelve months to September 2020).
Thus, Meiloon Industrial has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 11%.
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'd like to look at how Meiloon Industrial has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 3.4%. Basically the business is earning more per dollar of capital invested and in addition to that, 23% more capital is being employed now too. So we're very much inspired by what we're seeing at Meiloon Industrial thanks to its ability to profitably reinvest capital.
The Bottom Line On Meiloon Industrial's ROCE
To sum it up, Meiloon Industrial has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 188% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Meiloon Industrial can keep these trends up, it could have a bright future ahead.
One final note, you should learn about the 3 warning signs we've spotted with Meiloon Industrial (including 2 which make us uncomfortable) .
While Meiloon Industrial 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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