What trends should we look for it we want to identify stocks that can multiply in value over the long term? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s 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. However, after briefly looking over the numbers, we don’t think Lifestyle China Group (HKG:2136) has the makings of a multi-bagger going forward, but let’s have a look at why that may be.
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 Lifestyle China Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.0088 = CN¥117m ÷ (CN¥15b – CN¥1.4b) (Based on the trailing twelve months to December 2020).
So, Lifestyle China Group has an ROCE of 0.9%. In absolute terms, that’s a low return and it also under-performs the Multiline Retail industry average of 5.6%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you’re interested in investigating Lifestyle China Group’s past further, check out this free graph of past earnings, revenue and cash flow.
So How Is Lifestyle China Group’s ROCE Trending?
On the surface, the trend of ROCE at Lifestyle China Group doesn’t inspire confidence. To be more specific, ROCE has fallen from 3.0% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, Lifestyle China Group has decreased its current liabilities to 9.5% of total assets. Since the ratio used to be 69%, that’s a significant reduction and it no doubt explains the drop in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it’s own money, you could argue this has made the business less efficient at generating ROCE.
Our Take On Lifestyle China Group’s ROCE
Bringing it all together, while we’re somewhat encouraged by Lifestyle China Group’s reinvestment in its own business, we’re aware that returns are shrinking. Since the stock has declined 63% over the last three years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn’t have these traits of a multi-bagger discussed above, so if that’s what you’re looking for, we think you’d have more luck elsewhere.
One more thing, we’ve spotted 1 warning sign facing Lifestyle China Group that you might find interesting.
While Lifestyle China Group 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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