If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Yum China Holdings (NYSE:YUMC) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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. The formula for this calculation on Yum China Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$614m ÷ (US$7.0b - US$1.7b) (Based on the trailing twelve months to June 2020).
Thus, Yum China Holdings has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Hospitality industry.
In the above chart we have measured Yum China Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Yum China Holdings.
What Does the ROCE Trend For Yum China Holdings Tell Us?
When we looked at the ROCE trend at Yum China Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 22% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
Bringing it all together, while we're somewhat encouraged by Yum China Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 39% over the last three years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a separate note, we've found 1 warning sign for Yum China Holdings you'll probably want to know about.
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. 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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