Some Investors May Be Worried About CM Hi-Tech Cleanroom's (HKG:2115) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at CM Hi-Tech Cleanroom (HKG:2115), 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. To calculate this metric for CM Hi-Tech Cleanroom, this is the formula:

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

0.20 = CN¥64m ÷ (CN¥498m - CN¥170m) (Based on the trailing twelve months to December 2023).

Thus, CM Hi-Tech Cleanroom has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Building industry average of 13%.

Check out our latest analysis for CM Hi-Tech Cleanroom

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 CM Hi-Tech Cleanroom has performed in the past in other metrics, you can view this free graph of CM Hi-Tech Cleanroom's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at CM Hi-Tech Cleanroom, we didn't gain much confidence. Historically returns on capital were even higher at 28%, but they have dropped over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 34%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

In summary, we're somewhat concerned by CM Hi-Tech Cleanroom's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 67% return over the last three years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for CM Hi-Tech Cleanroom (of which 1 is significant!) that you should know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.