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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Viomi Technology (NASDAQ:VIOT) and its ROCE trend, we weren't exactly thrilled.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Viomi Technology, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥219m ÷ (CN¥3.2b - CN¥1.6b) (Based on the trailing twelve months to March 2021).
Therefore, Viomi Technology has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 14% generated by the Consumer Durables industry.
In the above chart we have measured Viomi Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Viomi Technology.
What Does the ROCE Trend For Viomi Technology Tell Us?
When we looked at the ROCE trend at Viomi Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 22% over the last four years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
Another thing to note, Viomi Technology has a high ratio of current liabilities to total assets of 49%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Viomi Technology. Furthermore the stock has climbed 19% over the last year, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 2 warning signs with Viomi Technology and understanding these should be part of your investment process.
While Viomi Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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