Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at Huami (NYSE:HMI) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for Huami, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = CN¥467m ÷ (CN¥5.2b - CN¥2.4b) (Based on the trailing twelve months to June 2020).
Thus, Huami has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 10% it's much better.
Above you can see how the current ROCE for Huami compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Huami.
What The Trend Of ROCE Can Tell Us
Huami has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making four years ago but is is now generating 17% on its capital. Not only that, but the company is utilizing 850% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 46%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.
The Key Takeaway
To the delight of most shareholders, Huami has now broken into profitability. And with a respectable 26% awarded to those who held the stock over the last year, you could argue that these trends are starting to get the attention they deserve. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Huami, we've discovered 1 warning sign that you should be aware of.
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.
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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