To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. With that in mind, we’ve noticed some promising trends at China State Construction Development Holdings (HKG:830) so let’s look a bit deeper.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for China State Construction Development Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.15 = HK$420m ÷ (HK$8.8b – HK$5.9b) (Based on the trailing twelve months to December 2021).
So, China State Construction Development Holdings has an ROCE of 15%. On its own, that’s a standard return, however it’s much better than the 11% generated by the Building industry.
Check out our latest analysis for China State Construction Development Holdings
In the above chart we have measured China State Construction Development Holdings’ 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 report on analyst forecasts for the company.
What Does the ROCE Trend For China State Construction Development Holdings Tell Us?
Investors would be pleased with what’s happening at China State Construction Development Holdings. The data shows that returns on capital have increased substantially over the last five years to 15%. The amount of capital employed has increased too, by 166%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that’s why we’re impressed.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 67% of its operations, which isn’t ideal. And with current liabilities at those levels, that’s pretty high.
The Bottom Line
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that’s what China State Construction Development Holdings has. Since the stock has returned a staggering 140% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we’ve identified 1 warning sign with China State Construction Development Holdings and understanding it should be part of your investment process.
While China State Construction Development Holdings 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.