What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Mao Bao (TPE:1732) and its trend of ROCE, we really liked what we saw.
Return On Capital Employed (ROCE): What is it?
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 Mao Bao, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.094 = NT$47m ÷ (NT$624m - NT$121m) (Based on the trailing twelve months to September 2020).
So, Mao Bao has an ROCE of 9.4%. Ultimately, that's a low return and it under-performs the Household Products industry average of 16%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Mao Bao's ROCE against it's prior returns. If you're interested in investigating Mao Bao's past further, check out this free graph of past earnings, revenue and cash flow.
What Does the ROCE Trend For Mao Bao Tell Us?
We're delighted to see that Mao Bao is reaping rewards from its investments and has now broken into profitability. The company now earns 9.4% on its capital, because five years ago it was incurring losses. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Key Takeaway
As discussed above, Mao Bao appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has returned a solid 85% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
One more thing to note, we've identified 2 warning signs with Mao Bao and understanding these should be part of your investment process.
While Mao Bao may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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This article by Simply Wall St is general in nature. 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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