What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Skyworth Group (HKG:751) and its trend of ROCE, we really liked what we saw.

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. Analysts use this formula to calculate it for Skyworth Group:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.059 = CN¥1.9b ÷ (CN¥69b - CN¥37b) (Based on the trailing twelve months to June 2024).

So, Skyworth Group has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 12%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Skyworth Group's ROCE against it's prior returns. If you'd like to look at how Skyworth Group has performed in the past in other metrics, you can view this free graph of Skyworth Group's past earnings, revenue and cash flow.

What Does the ROCE Trend For Skyworth Group Tell Us?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 5.9%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 52%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that Skyworth Group has a current liabilities to total assets ratio of 53%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

In summary, it's great to see that Skyworth Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a solid 48% to shareholders over the last five years, 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 to note, we've identified 2 warning signs with Skyworth Group and understanding these should be part of your investment process.

While Skyworth Group 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.