Capital Allocation Trends At Huazhang Technology Holding (HKG:1673) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Huazhang Technology Holding (HKG:1673), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Huazhang Technology Holding is:

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

0.038 = CN¥27m ÷ (CN¥1.4b - CN¥667m) (Based on the trailing twelve months to June 2021).

So, Huazhang Technology Holding has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 10.0%.

See our latest analysis for Huazhang Technology Holding

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huazhang Technology Holding's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Huazhang Technology Holding, check out these free graphs here.

What Can We Tell From Huazhang Technology Holding's ROCE Trend?

We weren't thrilled with the trend because Huazhang Technology Holding's ROCE has reduced by 66% over the last five years, while the business employed 159% more capital. That being said, Huazhang Technology Holding raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Huazhang Technology Holding probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a separate but related note, it's important to know that Huazhang Technology Holding has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Huazhang Technology Holding's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Huazhang Technology Holding is reinvesting for growth and has higher sales as a result. Despite these promising trends, the stock has collapsed 73% over the last five years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

If you'd like to know about the risks facing Huazhang Technology Holding, we've discovered 3 warning signs 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.

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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.