If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we’ll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Honmyue Enterprise (TPE:1474), we don’t think it’s current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Honmyue Enterprise is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.019 = NT$43m ÷ (NT$3.8b – NT$1.5b) (Based on the trailing twelve months to September 2020).
Thus, Honmyue Enterprise has an ROCE of 1.9%. In absolute terms, that’s a low return and it also under-performs the Luxury industry average of 4.0%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Honmyue Enterprise’s ROCE against it’s prior returns. If you want to delve into the historical earnings, revenue and cash flow of Honmyue Enterprise, check out these free graphs here.
The Trend Of ROCE
In terms of Honmyue Enterprise’s historical ROCE movements, the trend isn’t fantastic. To be more specific, ROCE has fallen from 5.2% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven’t increased.
What We Can Learn From Honmyue Enterprise’s ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Honmyue Enterprise have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 53% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don’t bode well for long term performance so unless they reverse, we’d start looking elsewhere.
Honmyue Enterprise does have some risks, we noticed 4 warning signs (and 2 which shouldn’t be ignored) we think you should know about.
While Honmyue Enterprise isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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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