To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we’ll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. 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.
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. 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)
0.01 = CN¥135m ÷ (CN¥14b – CN¥1.1b) (Based on the trailing twelve months to June 2020).
Thus, Lifestyle China Group has an ROCE of 1.0%. Ultimately, that’s a low return and it under-performs the Multiline Retail industry average of 7.2%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Lifestyle China Group’s ROCE against it’s prior returns. If you want to delve into the historical earnings, revenue and cash flow of Lifestyle China Group, check out these free graphs here.
How Are Returns Trending?
In terms of Lifestyle China Group’s historical ROCE movements, the trend isn’t fantastic. To be more specific, ROCE has fallen from 2.6% 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’s worth keeping an eye on the company’s earnings from here on to see if these investments do end up contributing to the bottom line.
On a related note, Lifestyle China Group has decreased its current liabilities to 7.6% of total assets. Since the ratio used to be 69%, that’s a significant reduction and it no doubt explains the drop in ROCE. 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. 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.
What We Can Learn From Lifestyle China Group’s ROCE
To conclude, we’ve found that Lifestyle China Group is reinvesting in the business, but returns have been falling. Since the stock has declined 39% over the last three years, investors may not be too optimistic on this trend improving either. On the whole, we aren’t too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Lifestyle China Group does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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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