To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. In light of that, when we looked at Hubei W-olf Photoelectric Technology (SZSE:002962) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Hubei W-olf Photoelectric Technology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.01 = CN¥19m ÷ (CN¥2.0b - CN¥157m) (Based on the trailing twelve months to September 2023).
Therefore, Hubei W-olf Photoelectric Technology has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 7.3%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hubei W-olf Photoelectric Technology's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hubei W-olf Photoelectric Technology, check out these free graphs here.
What Can We Tell From Hubei W-olf Photoelectric Technology's ROCE Trend?
In terms of Hubei W-olf Photoelectric Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 1.0% from 18% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a side note, Hubei W-olf Photoelectric Technology has done well to pay down its current liabilities to 7.8% of total assets. That could partly explain why the ROCE has dropped. 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.
Our Take On Hubei W-olf Photoelectric Technology's ROCE
We're a bit apprehensive about Hubei W-olf Photoelectric Technology because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 15% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing Hubei W-olf Photoelectric Technology we've found 4 warning signs (2 are potentially serious!) that you should be aware of before investing here.
While Hubei W-olf Photoelectric Technology 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.
