Capital Allocation Trends At Channel Micron Holdings (HKG:2115) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Channel Micron Holdings (HKG:2115), we don't think it's current trends fit the mold of a multi-bagger.

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

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. The formula for this calculation on Channel Micron Holdings is:

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

0.18 = CN¥40m ÷ (CN¥394m - CN¥165m) (Based on the trailing twelve months to December 2021).

So, Channel Micron Holdings has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 11% generated by the Building industry.

Check out our latest analysis for Channel Micron Holdings

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

What Does the ROCE Trend For Channel Micron Holdings Tell Us?

When we looked at the ROCE trend at Channel Micron Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 25% over the last four years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. 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 42%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 18%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Channel Micron Holdings. Furthermore the stock has climbed 60% over the last year, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know more about Channel Micron Holdings, we've spotted 3 warning signs, and 1 of them is concerning.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.