What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in So-Young International’s (NASDAQ:SY) returns on capital, so let’s have a look.
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 So-Young International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.014 = CN¥41m ÷ (CN¥3.3b – CN¥499m) (Based on the trailing twelve months to June 2020).
Thus, So-Young International has an ROCE of 1.4%. Ultimately, that’s a low return and it under-performs the Interactive Media and Services industry average of 6.7%.
In the above chart we have measured So-Young International’s 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 So-Young International.
How Are Returns Trending?
So-Young International has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making three years ago but is is now generating 1.4% on its capital. Not only that, but the company is utilizing 975% more capital than before, but that’s to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.On a related note, the company’s ratio of current liabilities to total assets has decreased to 15%, which basically reduces it’s funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business’ fundamental improvements, rather than a cooking class featuring this company’s books.
The Bottom Line On So-Young International’s ROCE
Overall, So-Young International gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 12% to shareholders over the last year, it’s fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing, we’ve spotted 1 warning sign facing So-Young International that you might find interesting.
While So-Young International 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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