What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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, the ROCE of China Ceramics (NASDAQ:CCCL) looks great, so lets see what the trend can tell us.
What is Return On Capital Employed (ROCE)?
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 China Ceramics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = CN¥56m ÷ (CN¥307m - CN¥91m) (Based on the trailing twelve months to June 2020).
Therefore, China Ceramics has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Building industry average of 14%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for China Ceramics' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of China Ceramics, check out these free graphs here.
What Can We Tell From China Ceramics' ROCE Trend?
We're pretty happy with how the ROCE has been trending at China Ceramics. We found that the returns on capital employed over the last five years have risen by 370%. The company is now earning CN¥0.3 per dollar of capital employed. Interestingly, the business may be becoming more efficient because it's applying 85% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 30% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From China Ceramics' ROCE
In the end, China Ceramics has proven it's capital allocation skills are good with those higher returns from less amount of capital. Although the company may be facing some issues elsewhere since the stock has plunged 90% in the last five years. In any case, we believe the economic trends of this company are positive and looking into the stock further could prove rewarding.
China Ceramics does come with some risks though, we found 4 warning signs in our investment analysis, and 3 of those don't sit too well with us...
China Ceramics is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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