Be Wary Of Unity Enterprise Holdings (HKG:2195) And Its Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Unity Enterprise Holdings (HKG:2195), we don't think it's current trends fit the mold of a multi-bagger.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Unity Enterprise Holdings is:

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

0.15 = HK$26m ÷ (HK$280m - HK$110m) (Based on the trailing twelve months to June 2022).

Therefore, Unity Enterprise Holdings has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 7.0% it's much better.

See our latest analysis for Unity Enterprise Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Unity Enterprise Holdings' ROCE against it's prior returns. If you're interested in investigating Unity Enterprise Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Unity Enterprise Holdings' ROCE Trending?

On the surface, the trend of ROCE at Unity Enterprise Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 54% five years ago. 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.

On a related note, Unity Enterprise Holdings has decreased its current liabilities to 39% 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.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Unity Enterprise Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 66% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Unity Enterprise Holdings (of which 3 are a bit unpleasant!) that you should know about.

While Unity Enterprise Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.