If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Henglin Home FurnishingsLtd (SHSE:603661) looks quite promising in regards to its trends of return on capital.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Henglin Home FurnishingsLtd is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = CN¥524m ÷ (CN¥10b - CN¥4.4b) (Based on the trailing twelve months to March 2024).
Thus, Henglin Home FurnishingsLtd has an ROCE of 9.1%. In absolute terms, that's a low return, but it's much better than the Commercial Services industry average of 4.6%.
In the above chart we have measured Henglin Home FurnishingsLtd'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 Henglin Home FurnishingsLtd .
The Trend Of ROCE
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 9.1%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 141%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.
The Bottom Line
To sum it up, Henglin Home FurnishingsLtd has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 68% return over the last five years. In light of that, we think it's worth looking further into this stock because if Henglin Home FurnishingsLtd can keep these trends up, it could have a bright future ahead.
Henglin Home FurnishingsLtd does have some risks, we noticed 2 warning signs (and 1 which is potentially serious) we think you should know about.
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.
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