In Construction Holdings' (HKG:1500) Returns Have Hit A Wall

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. So when we looked at In Construction Holdings (HKG:1500), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for In Construction Holdings, this is the formula:

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

0.28 = HK$101m ÷ (HK$548m - HK$185m) (Based on the trailing twelve months to September 2021).

Thus, In Construction Holdings has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 8.7% earned by companies in a similar industry.

View our latest analysis for In Construction 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 want to delve into the historical earnings, revenue and cash flow of In Construction Holdings, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

Things have been pretty stable at In Construction Holdings, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So it may not be a multi-bagger in the making, but given the decent 28% return on capital, it'd be difficult to find fault with the business's current operations.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 34% of total assets, this reported ROCE would probably be less than28% because total capital employed would be higher.The 28% ROCE could be even lower if current liabilities weren't 34% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

Our Take On In Construction Holdings' ROCE

In summary, In Construction Holdings isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Since the stock has declined 56% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for In Construction Holdings (of which 1 is potentially serious!) that you should know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.