Landrich Holding (HKG:2132) May Have Issues Allocating Its 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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Landrich Holding (HKG:2132) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Landrich Holding, this is the formula:

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

0.17 = HK$40m ÷ (HK$371m - HK$138m) (Based on the trailing twelve months to March 2021).

So, Landrich Holding has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 7.8% it's much better.

Check out our latest analysis for Landrich Holding

Historical performance is a great place to start when researching a stock so above you can see the gauge for Landrich Holding's ROCE against it's prior returns. If you'd like to look at how Landrich Holding has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Landrich Holding's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 49%, but since then they've fallen to 17%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Landrich Holding has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Landrich Holding's ROCE

Bringing it all together, while we're somewhat encouraged by Landrich Holding's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 22% over the last year, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know more about Landrich Holding, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.

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.

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.

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