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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Xiaomi (HKG:1810) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Xiaomi is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = CN¥20b ÷ (CN¥293b - CN¥116b) (Based on the trailing twelve months to December 2021).
Thus, Xiaomi has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 9.0% generated by the Tech industry.
In the above chart we have measured Xiaomi's prior ROCE against its prior performance, but the future is arguably more important.
The Trend Of ROCE
Xiaomi is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 616%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a related note, the company's ratio of current liabilities to total assets has decreased to 40%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
In Conclusion
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Xiaomi has. Investors may not be impressed by the favorable underlying trends yet because over the last three years the stock has only returned 11% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.
Comments