Returns On Capital Signal Tricky Times Ahead For Central Holding Group (HKG:1735)

There are a few key trends to look for if we want to identify the next multi-bagger. 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. However, after investigating Central Holding Group (HKG:1735), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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. The formula for this calculation on Central Holding Group is:

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

0.013 = HK$4.6m ÷ (HK$907m - HK$559m) (Based on the trailing twelve months to June 2022).

Thus, Central Holding Group has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.0%.

See our latest analysis for Central Holding Group

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

What Can We Tell From Central Holding Group's ROCE Trend?

When we looked at the ROCE trend at Central Holding Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.3% from 40% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 62%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. 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 Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Central Holding Group. And long term investors must be optimistic going forward because the stock has returned a huge 590% to shareholders in the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing to note, we've identified 1 warning sign with Central Holding Group and understanding it should be part of your investment process.

While Central Holding Group isn't earning the highest return, check out this free list of companies that are 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.