What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at China Literature (HKG:772) and its trend of ROCE, we really liked what we saw.
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. To calculate this metric for China Literature, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CN¥760m ÷ (CN¥24b - CN¥4.9b) (Based on the trailing twelve months to June 2024).
Therefore, China Literature has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Media industry average of 8.5%.
In the above chart we have measured China Literature'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 China Literature .
What The Trend Of ROCE Can Tell Us
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 86% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
The Bottom Line
To sum it up, China Literature is collecting higher returns from the same amount of capital, and that's impressive. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. So researching this company further and determining whether or not these trends will continue seems justified.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for 772 on our platform that is definitely worth checking out.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
