There Are Reasons To Feel Uneasy About Heng Hup Holdings' (HKG:1891) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Heng Hup Holdings (HKG:1891) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Heng Hup Holdings is:

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

0.12 = RM26m ÷ (RM319m - RM94m) (Based on the trailing twelve months to June 2022).

So, Heng Hup Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 4.1% it's much better.

Our analysis indicates that 1891 is potentially undervalued!

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'd like to look at how Heng Hup Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Heng Hup Holdings' ROCE Trend?

When we looked at the ROCE trend at Heng Hup Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 36%, but since then they've fallen to 12%. 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.

On a side note, Heng Hup Holdings has done well to pay down its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Heng Hup Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Heng Hup Holdings is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 12% gain to shareholders who've held over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

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

While Heng Hup Holdings 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.