What trends should we look for if we are to identify stocks that can multiply in value over the long term? Ideally, a business will display two trends; first growth to return to on capital employed (ROCE) and on the other hand, an increase quantity capital employed. This shows us that it is a composing machine, capable of continually reinvesting its profits into the business and generating higher returns. So when we looked Guangdong Tannery (HKG: 1058) and its trend of ROCE, we really liked what we saw.
What is Return on Employee Capital (ROCE)?
If you’ve never worked with ROCE before, it measures the “return” (profit before tax) that a business generates on capital employed in its business. To calculate this metric for Guangdong Tannery, here is the formula:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.026 = HK $ 4.9million ÷ (HK $ 258million – HK $ 70million) (Based on the last twelve months up to June 2021).
Therefore, Guangdong Tannery has a ROCE of 2.6%. In absolute terms, this is a low return and it is also below the luxury industry average of 7.0%.
See our latest analysis for Guangdong Tannery
Historical performance is a great place to start when looking for a stock. So above you can see Guangdong Tannery’s ROCE gauge against its past returns. If you want to delve into the history of Guangdong Tannery profit, income and cash flow, check out these free graphics here.
What the ROCE trend can tell us
We are delighted to see that Guangdong Tannery is reaping the benefits of its investments and has now returned to profitability. While the company is now profitable, it incurred losses on the capital invested five years ago. Additionally, the business is using 53% less capital than it was five years ago, and at face value that may mean the business needs less cash at work to earn a return. The reduction could indicate that the company is selling some assets and, given that yields are rising, it appears to be selling the good ones.
The bottom line
From what we have seen above, Guangdong Tannery has been successful in increasing its returns on capital while reducing its capital base. Investors may not yet be impressed with the favorable underlying trends, as over the past five years, the stock has only returned 14% to shareholders. Therefore, further exploring this stock might reveal a good opportunity, if valuation and other metrics stack up.
If you want to know more about Guangdong Tannery, we have spotted 4 warning signs, and 1 of them should not be ignored.
If you want to look for solid businesses with great income, check out this free list of companies with good balance sheets and impressive returns on equity.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.