Investors Will Want Zhidao International (Holdings)'s (HKG:1220) Growth In ROCE To Persist

July 04, 2023

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. So when we looked at Zhidao International (Holdings) (HKG:1220) and its trend of ROCE, we really liked what we saw.

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. The formula for this calculation on Zhidao International (Holdings) is:

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

0.004 = HK$1.1m ÷ (HK$409m - HK$122m) (Based on the trailing twelve months to March 2023).

So, Zhidao International (Holdings) has an ROCE of 0.4%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.1%.

View our latest analysis for Zhidao International (Holdings)

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 Zhidao International (Holdings)'s past further, check out this free graph of past earnings, revenue and cash flow.

SWOT Analysis for Zhidao International (Holdings)

Strength

Debt is well covered by .

Balance sheet summary for 1220.

Weakness

Interest payments on debt are not well covered.

Opportunity

Has sufficient cash runway for more than 3 years based on current free cash flows.

Lack of analyst coverage makes it difficult to determine 1220's earnings prospects.

Threat

Debt is not well covered by operating cash flow.

Is 1220 well equipped to handle threats?

What The Trend Of ROCE Can Tell Us

We're delighted to see that Zhidao International (Holdings) is reaping rewards from its investments and has now broken into profitability. While the business is profitable now, it used to be incurring losses on invested capital five years ago. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 37%. This could potentially mean that the company is selling some of its assets.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 30% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

In Conclusion...

From what we've seen above, Zhidao International (Holdings) has managed to increase it's returns on capital all the while reducing it's capital base. And since the stock has dived 97% over the last five years, there may be other factors affecting the company's prospects. Regardless, we think the underlying fundamentals warrant this stock for further investigation.

If you'd like to know more about Zhidao International (Holdings), we've spotted 3 warning signs, and 2 of them are potentially serious.

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.

Valuation is complex, but we're here to simplify it.

Discover if Zhidao International (Holdings) might be undervalued or overvalued with our detailed analysis, featuring fair value estimates, potential risks, dividends, insider trades, and its financial condition.

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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.