If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Colorlight Cloud Tech (SZSE:301391) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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. The formula for this calculation on Colorlight Cloud Tech is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = CN¥120m ÷ (CN¥2.7b - CN¥553m) (Based on the trailing twelve months to September 2023).
Therefore, Colorlight Cloud Tech has an ROCE of 5.5%. On its own, that's a low figure but it's around the 5.1% average generated by the Electronic industry.
In the above chart we have measured Colorlight Cloud Tech's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Colorlight Cloud Tech .
How Are Returns Trending?
On the surface, the trend of ROCE at Colorlight Cloud Tech doesn't inspire confidence. Over the last four years, returns on capital have decreased to 5.5% from 58% four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, Colorlight Cloud Tech has decreased its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Colorlight Cloud Tech is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 2.0% gain to shareholders who've held over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
If you want to continue researching Colorlight Cloud Tech, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Colorlight Cloud Tech 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.