What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Having said that, from a first glance at JHT DesignLtd (SHSE:603061) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on JHT DesignLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = CN¥90m ÷ (CN¥1.6b - CN¥189m) (Based on the trailing twelve months to September 2023).
Therefore, JHT DesignLtd has an ROCE of 6.6%. On its own, that's a low figure but it's around the 5.6% average generated by the Semiconductor industry.
In the above chart we have measured JHT DesignLtd'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 JHT DesignLtd .
So How Is JHT DesignLtd's ROCE Trending?
In terms of JHT DesignLtd's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last four years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a side note, JHT DesignLtd has done well to pay down its current liabilities to 12% 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
From the above analysis, we find it rather worrisome that returns on capital and sales for JHT DesignLtd have fallen, meanwhile the business is employing more capital than it was four years ago. It should come as no surprise then that the stock has fallen 30% over the last year, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One final note, you should learn about the 2 warning signs we've spotted with JHT DesignLtd (including 1 which can't be ignored) .
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.