Capital Allocation Trends At Hangzhou Honghua Digital Technology Stock (SHSE:688789) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Hangzhou Honghua Digital Technology Stock (SHSE:688789) 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)?

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. Analysts use this formula to calculate it for Hangzhou Honghua Digital Technology Stock:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = CN¥342m ÷ (CN¥3.6b - CN¥547m) (Based on the trailing twelve months to March 2024).

Thus, Hangzhou Honghua Digital Technology Stock has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 5.6% it's much better.

View our latest analysis for Hangzhou Honghua Digital Technology Stock

In the above chart we have measured Hangzhou Honghua Digital Technology Stock'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 analyst report for Hangzhou Honghua Digital Technology Stock .

How Are Returns Trending?

When we looked at the ROCE trend at Hangzhou Honghua Digital Technology Stock, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 26% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

While returns have fallen for Hangzhou Honghua Digital Technology Stock in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 57% over the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Hangzhou Honghua Digital Technology Stock does come with some risks, and we've found 1 warning sign that you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com