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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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. 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 Ever-Glory International Group (NASDAQ:EVK) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Ever-Glory International Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = US$4.1m ÷ (US$332m - US$189m) (Based on the trailing twelve months to December 2020).
Thus, Ever-Glory International Group has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 15%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Ever-Glory International Group's ROCE against it's prior returns. If you'd like to look at how Ever-Glory International Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Ever-Glory International Group doesn't inspire confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 2.9%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
Another thing to note, Ever-Glory International Group has a high ratio of current liabilities to total assets of 57%. 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
In summary, we're somewhat concerned by Ever-Glory International Group's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 44% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know more about Ever-Glory International Group, we've spotted 4 warning signs, and 1 of them is significant.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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