Returns On Capital Signal Tricky Times Ahead For Wecon Holdings (HKG:1793)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Wecon Holdings (HKG:1793) and its ROCE trend, we weren't exactly thrilled.

What is 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 Wecon Holdings, this is the formula:

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

0.032 = HK$9.2m ÷ (HK$538m - HK$252m) (Based on the trailing twelve months to September 2021).

So, Wecon Holdings has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the Construction industry average of 8.7%.

Check out our latest analysis for Wecon Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Wecon Holdings' ROCE against it's prior returns. If you're interested in investigating Wecon Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Wecon Holdings' ROCE Trending?

In terms of Wecon Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 28% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Wecon Holdings has decreased its current liabilities to 47% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 47% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

In summary, we're somewhat concerned by Wecon Holdings' diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 11% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Wecon Holdings (of which 2 are significant!) that you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.