If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at FriendLtd (SHSE:605050) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 FriendLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = CN¥516m ÷ (CN¥6.7b - CN¥2.5b) (Based on the trailing twelve months to September 2023).
Therefore, FriendLtd has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 6.3% generated by the Metals and Mining industry.
In the above chart we have measured FriendLtd'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 FriendLtd .
So How Is FriendLtd's ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 24% five years ago, while the business's capital employed increased by 181%. Usually this isn't ideal, but given FriendLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. FriendLtd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.
On a side note, FriendLtd has done well to pay down its current liabilities to 37% 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.
The Bottom Line On FriendLtd's ROCE
Bringing it all together, while we're somewhat encouraged by FriendLtd'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 7.2% to shareholders over the last three years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.
If you want to know some of the risks facing FriendLtd we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.
