What are the early trends we should look for to identify a stock that could 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. However, after briefly looking over the numbers, we don't think Shanghai Emperor of Cleaning Hi-Tech (SHSE:603200) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Shanghai Emperor of Cleaning Hi-Tech is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.048 = CN¥52m ÷ (CN¥1.6b - CN¥518m) (Based on the trailing twelve months to September 2024).
Thus, Shanghai Emperor of Cleaning Hi-Tech has an ROCE of 4.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.3%.
In the above chart we have measured Shanghai Emperor of Cleaning Hi-Tech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Emperor of Cleaning Hi-Tech for free.
What The Trend Of ROCE Can Tell Us
In terms of Shanghai Emperor of Cleaning Hi-Tech's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 7.3% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Shanghai Emperor of Cleaning Hi-Tech's current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
What We Can Learn From Shanghai Emperor of Cleaning Hi-Tech's ROCE
To conclude, we've found that Shanghai Emperor of Cleaning Hi-Tech is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 106% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you're still interested in Shanghai Emperor of Cleaning Hi-Tech it's worth checking out our FREE intrinsic value approximation for 603200 to see if it's trading at an attractive price in other respects.
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.
