If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. In light of that, when we looked at Longyan Kaolin Clay (SHSE:605086) and its ROCE trend, we weren't exactly thrilled.
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 Longyan Kaolin Clay is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.087 = CN¥101m ÷ (CN¥1.2b - CN¥77m) (Based on the trailing twelve months to September 2023).
Therefore, Longyan Kaolin Clay has an ROCE of 8.7%. On its own that's a low return, but compared to the average of 6.1% generated by the Basic Materials industry, it's much better.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Longyan Kaolin Clay's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Longyan Kaolin Clay.
How Are Returns Trending?
On the surface, the trend of ROCE at Longyan Kaolin Clay doesn't inspire confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 8.7%. However it looks like Longyan Kaolin Clay might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Longyan Kaolin Clay has done well to pay down its current liabilities to 6.2% 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. 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.
The Bottom Line
Bringing it all together, while we're somewhat encouraged by Longyan Kaolin Clay's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 13% in the last year. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
On a final note, we found 2 warning signs for Longyan Kaolin Clay (1 doesn't sit too well with us) you should be aware of.
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.