Here's What's Concerning About Unity Enterprise Holdings' (HKG:2195) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. So when we looked at Unity Enterprise Holdings (HKG:2195), they do have a high ROCE, but we weren't exactly elated from 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. Analysts use this formula to calculate it for Unity Enterprise Holdings:

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

0.20 = HK$33m ÷ (HK$278m - HK$116m) (Based on the trailing twelve months to December 2021).

So, Unity Enterprise Holdings has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 8.6% earned by companies in a similar industry.

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'd like to look at how Unity Enterprise Holdings 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

When we looked at the ROCE trend at Unity Enterprise Holdings, we didn't gain much confidence. Historically returns on capital were even higher at 59%, but they have dropped over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Unity Enterprise Holdings has decreased its current liabilities to 42% of total assets. That could partly explain why the ROCE has dropped. 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. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Unity Enterprise Holdings' ROCE

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. However the stock has delivered a 18% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to continue researching Unity Enterprise Holdings, you might be interested to know about the 2 warning signs that our analysis has discovered.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.