Here's What To Make Of Acme International Holdings' (HKG:1870) Decelerating Rates Of Return

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at Acme International Holdings (HKG:1870), it does have a high ROCE right now, but lets see how returns are trending.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Acme International Holdings:

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

0.26 = HK$26m ÷ (HK$173m - HK$74m) (Based on the trailing twelve months to June 2023).

So, Acme International Holdings has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Construction industry average of 7.8%.

View our latest analysis for Acme International Holdings

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 Acme International Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 61% in that same period. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. However, the business's operational efficiency is still impressive considering the ROCE is high in absolute terms.

On a separate but related note, it's important to know that Acme International Holdings has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

It's a shame to see that Acme International Holdings is effectively shrinking in terms of its capital base. Yet to long term shareholders the stock has gifted them an incredible 664% return in the last three years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 2 warning signs with Acme International Holdings and understanding them should be part of your investment process.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.