If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 while Vtech Holdings (HKG:303) has a high ROCE right now, lets see what we can decipher from how returns are changing.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Vtech Holdings is:

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

0.25 = US$192m ÷ (US$1.4b - US$593m) (Based on the trailing twelve months to September 2023).

Therefore, Vtech Holdings has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Communications industry average of 5.1%.

See our latest analysis for Vtech Holdings

Above you can see how the current ROCE for Vtech Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Vtech Holdings.

So How Is Vtech Holdings' ROCE Trending?

When we looked at the ROCE trend at Vtech Holdings, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 37% where it was 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Vtech Holdings has done well to pay down its current liabilities to 44% of total assets. So we could link some of this to the decrease in ROCE. 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. Keep in mind 44% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Vtech Holdings' reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 7.5% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

Vtech Holdings does have some risks, we noticed 2 warning signs (and 1 which is concerning) we think you should know about.

Vtech Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.