If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. So when we looked at XGD (SZSE:300130) and its trend of ROCE, we really liked what we saw.
What Is 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 XGD:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = CN¥496m ÷ (CN¥5.0b - CN¥1.0b) (Based on the trailing twelve months to September 2023).
So, XGD has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 5.0% generated by the Electronic industry.
View our latest analysis for XGD
In the above chart we have measured XGD'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 XGD.
The Trend Of ROCE
XGD is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 12%. The amount of capital employed has increased too, by 80%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
On a related note, the company's ratio of current liabilities to total assets has decreased to 20%, 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 Key Takeaway
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what XGD has. Since the stock has returned a solid 81% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if XGD can keep these trends up, it could have a bright future ahead.
On a separate note, we've found 3 warning signs for XGD you'll probably want to know about.
While XGD 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.
