Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. 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 China Lesso Group Holdings (HKG:2128), we don't think it's current trends fit the mold of a multi-bagger.
Our free stock report includes 2 warning signs investors should be aware of before investing in China Lesso Group Holdings. Read for free now.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. To calculate this metric for China Lesso Group Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = CN¥3.8b ÷ (CN¥58b - CN¥22b) (Based on the trailing twelve months to December 2024).
Thus, China Lesso Group Holdings has an ROCE of 10%. That's a relatively normal return on capital, and it's around the 9.2% generated by the Building industry.
See our latest analysis for China Lesso Group Holdings
Above you can see how the current ROCE for China Lesso Group Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for China Lesso Group Holdings .
How Are Returns Trending?
On the surface, the trend of ROCE at China Lesso Group Holdings doesn't inspire confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 10%. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
On a related note, China Lesso Group Holdings has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line On China Lesso Group Holdings' ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for China Lesso Group Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 51% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
China Lesso Group Holdings does have some risks though, and we've spotted 2 warning signs for China Lesso Group Holdings that you might be interested in.
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.
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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.