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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Hollysys Automation Technologies (NASDAQ:HOLI) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What is 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 Hollysys Automation Technologies is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$105m ÷ (US$1.4b - US$327m) (Based on the trailing twelve months to June 2020).
Therefore, Hollysys Automation Technologies has an ROCE of 10%. That's a pretty standard return and it's in line with the industry average of 10%.
Above you can see how the current ROCE for Hollysys Automation Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
On the surface, the trend of ROCE at Hollysys Automation Technologies doesn't inspire confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 10%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
On a related note, Hollysys Automation Technologies has decreased its current liabilities to 24% of total assets. So we could link some of this to the decrease 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 Hollysys Automation Technologies' ROCE
We're a bit apprehensive about Hollysys Automation Technologies because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 35% from where it was five years ago. Unless these trends revert to a more positive trajectory, we would look elsewhere.
One more thing to note, we've identified 3 warning signs with Hollysys Automation Technologies and understanding them should be part of your investment process.
While Hollysys Automation Technologies 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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