If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Although, when we looked at Changsha Tongcheng HoldingsLtd (SZSE:000419), it didn't seem to tick all of these boxes.
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. To calculate this metric for Changsha Tongcheng HoldingsLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.032 = CN¥138m ÷ (CN¥5.5b - CN¥1.1b) (Based on the trailing twelve months to September 2023).
Thus, Changsha Tongcheng HoldingsLtd has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 5.3%.
See our latest analysis for Changsha Tongcheng HoldingsLtd
Historical performance is a great place to start when researching a stock so above you can see the gauge for Changsha Tongcheng HoldingsLtd's ROCE against it's prior returns. If you're interested in investigating Changsha Tongcheng HoldingsLtd's past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Changsha Tongcheng HoldingsLtd doesn't inspire confidence. Around five years ago the returns on capital were 6.0%, but since then they've fallen to 3.2%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by Changsha Tongcheng HoldingsLtd's 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 23% to shareholders over the last five years. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
One more thing: We've identified 3 warning signs with Changsha Tongcheng HoldingsLtd (at least 1 which is concerning) , and understanding them would certainly be useful.
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.
