If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. Although, when we looked at NVH Korea (KOSDAQ:067570), it didn’t seem to tick all of these boxes.
Understanding 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. The formula for this calculation on NVH Korea is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.057 = ₩25b ÷ (₩856b – ₩406b) (Based on the trailing twelve months to December 2020).
Thus, NVH Korea has an ROCE of 5.7%. On its own that’s a low return, but compared to the average of 4.6% generated by the Auto Components industry, it’s much better.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you’re interested in investigating NVH Korea’s past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
The trend of ROCE doesn’t look fantastic because it’s fallen from 9.8% five years ago, while the business’s capital employed increased by 186%. Usually this isn’t ideal, but given NVH Korea conducted a capital raising before their most recent earnings announcement, that would’ve likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven’t been put to work yet so it’s worth watching what happens in the future with NVH Korea’s earnings and if they change as a result from the capital raise. Additionally, we found that NVH Korea’s most recent EBIT figure is around the same as the prior year, so we’d attribute the drop in ROCE mostly to the capital raise.
On a side note, NVH Korea has done well to pay down its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.
The Key Takeaway
While returns have fallen for NVH Korea in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 91% over the last five years, 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.
If you want to know some of the risks facing NVH Korea we’ve found 5 warning signs (2 can’t be ignored!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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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