The Returns On Capital At Huazhang Technology Holding (HKG:1673) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Huazhang Technology Holding (HKG:1673), it didn't seem to tick all of these boxes.

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. To calculate this metric for Huazhang Technology Holding, this is the formula:

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

0.0066 = CN¥4.4m ÷ (CN¥1.3b - CN¥664m) (Based on the trailing twelve months to December 2020).

Therefore, Huazhang Technology Holding has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 8.5%.

Check out our latest analysis for Huazhang Technology Holding

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 Huazhang Technology Holding's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We weren't thrilled with the trend because Huazhang Technology Holding's ROCE has reduced by 88% over the last five years, while the business employed 162% more capital. Usually this isn't ideal, but given Huazhang Technology Holding conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Huazhang Technology Holding's earnings and if they change as a result from the capital raise.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 50%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 0.7%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

We're a bit apprehensive about Huazhang Technology Holding because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 29% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Huazhang Technology Holding does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

While Huazhang Technology Holding may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. 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.
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