Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Qingdao Topscomm Communication (SHSE:603421) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Qingdao Topscomm Communication:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.03 = CN¥123m ÷ (CN¥5.6b - CN¥1.4b) (Based on the trailing twelve months to September 2023).
Therefore, Qingdao Topscomm Communication has an ROCE of 3.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 4.4%.
View our latest analysis for Qingdao Topscomm Communication
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Qingdao Topscomm Communication's past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
In terms of Qingdao Topscomm Communication's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.0% from 10% five years ago. 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.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 25%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 3.0%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Bottom Line
In summary, Qingdao Topscomm Communication is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 31% in the last five years. Therefore based on the analysis done in this article, we don't think Qingdao Topscomm Communication has the makings of a multi-bagger.
Qingdao Topscomm Communication does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...
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. 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.
