Here's What's Concerning About SH Group (Holdings)'s (HKG:1637) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at SH Group (Holdings) (HKG:1637) 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)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for SH Group (Holdings), this is the formula:

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

0.07 = HK$20m ÷ (HK$508m - HK$216m) (Based on the trailing twelve months to March 2022).

So, SH Group (Holdings) has an ROCE of 7.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.0%.

Check out the opportunities and risks within the HK Construction industry.

Historical performance is a great place to start when researching a stock so above you can see the gauge for SH Group (Holdings)'s ROCE against it's prior returns. If you'd like to look at how SH Group (Holdings) has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From SH Group (Holdings)'s ROCE Trend?

When we looked at the ROCE trend at SH Group (Holdings), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.0% from 17% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 43%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 7.0%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

In summary, SH Group (Holdings) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 46% 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.

One more thing, we've spotted 4 warning signs facing SH Group (Holdings) that you might find interesting.

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. 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.