China Strategic Holdings (HKG:235) May Have Issues Allocating Its Capital

What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within China Strategic Holdings (HKG:235), we weren't too hopeful.

What Is Return On Capital Employed (ROCE)?

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 China Strategic Holdings is:

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

0.033 = HK$75m ÷ (HK$2.3b - HK$38m) (Based on the trailing twelve months to June 2022).

Thus, China Strategic Holdings has an ROCE of 3.3%. Ultimately, that's a low return and it under-performs the Trade Distributors industry average of 4.3%.

View our latest analysis for China Strategic Holdings

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 China Strategic 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

The trend of ROCE at China Strategic Holdings is showing some signs of weakness. To be more specific, today's ROCE was 4.7% five years ago but has since fallen to 3.3%. In addition to that, China Strategic Holdings is now employing 46% less capital than it was five years ago. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.

On a related note, China Strategic Holdings has decreased its current liabilities to 1.6% 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.

In Conclusion...

To see China Strategic Holdings reducing the capital employed in the business in tandem with diminishing returns, is concerning. We expect this has contributed to the stock plummeting 80% during the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

China Strategic Holdings does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.