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

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Unity Enterprise Holdings (HKG:2195), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Unity Enterprise Holdings, this is the formula:

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).

So, Unity Enterprise Holdings has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 7.2% generated by the Construction industry.

Our analysis indicates that 2195 is potentially undervalued!

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 Does the ROCE Trend For Unity Enterprise Holdings Tell Us?

When we looked at the ROCE trend at Unity Enterprise Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 54%, but since then they've fallen to 15%. And considering revenue has dropped while employing more capital, we'd be cautious. 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 side note, Unity Enterprise Holdings has done well to pay down its current liabilities to 39% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Unity Enterprise Holdings' ROCE

We're a bit apprehensive about Unity Enterprise Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last year have experienced a 58% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Unity Enterprise Holdings does come with some risks though, we found 5 warning signs in our investment analysis, and 3 of those are concerning...

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.