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 Ways ElectronLtd (SHSE:605218) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Ways ElectronLtd:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.044 = CN¥57m ÷ (CN¥1.7b - CN¥468m) (Based on the trailing twelve months to September 2023).
So, Ways ElectronLtd has an ROCE of 4.4%. On its own, that's a low figure but it's around the 5.4% average generated by the Electronic industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Ways ElectronLtd'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 Ways ElectronLtd.
The Trend Of ROCE
On the surface, the trend of ROCE at Ways ElectronLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.4% from 32% five years ago. However it looks like Ways ElectronLtd 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 related note, Ways ElectronLtd has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Key Takeaway
In summary, Ways ElectronLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly, the stock has only gained 13% over the last three years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
Ways ElectronLtd does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those makes us a bit uncomfortable...
While Ways ElectronLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.