There are a few key trends to look for if we want to identify the next multi-bagger. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Hollysys Automation Technologies (NASDAQ:HOLI), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Hollysys Automation Technologies:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.095 = US$103m ÷ (US$1.5b - US$374m) (Based on the trailing twelve months to September 2020).
Thus, Hollysys Automation Technologies has an ROCE of 9.5%. In absolute terms, that's a low return but it's around the Electronic industry average of 11%.
In the above chart we have measured Hollysys Automation Technologies' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Hollysys Automation Technologies here for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Hollysys Automation Technologies doesn't inspire confidence. To be more specific, ROCE has fallen from 21% over the last five years. However it looks like Hollysys Automation Technologies might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.On a side note, Hollysys Automation Technologies has done well to pay down its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Hollysys Automation Technologies' ROCE
Bringing it all together, while we're somewhat encouraged by Hollysys Automation Technologies' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 39% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
On a final note, we've found 3 warning signs for Hollysys Automation Technologies that we think you should be aware of.
While Hollysys Automation Technologies 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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