Good Friend International Holdings Inc (HKG:2398): Assessing Capital Returns

I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Good Friend International Holdings Inc (HKG:2398).

If you purchase a 2398 share you are effectively becoming a partner with many other shareholders. Owing to this, it is important that the underlying business is producing a sufficient amount of income from the capital invested by stockholders. Your return is tied to 2398’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand Good Friend International Holdings’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.

View our latest analysis for Good Friend International Holdings

Calculating Return On Capital Employed for 2398

You only have a finite amount of capital to invest, so there are only so many companies that you can add to your portfolio. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine Good Friend International Holdings’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). I have calculated Good Friend International Holdings’s ROCE for you below:

ROCE Calculation for 2398

Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)

Capital Employed = (Total Assets – Current Liabilities)

∴ ROCE = CN¥69m ÷ (CN¥2.1b – CN¥1.2b) = 8.0%

2398’s 8.0% ROCE means that for every HK$100 you invest, the company creates HK$8. This makes Good Friend International Holdings unattractive when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital will be able to compound over time, but not to the extent investors should be aiming for.

SEHK:2398 Last Perf October 24th 18
SEHK:2398 Last Perf October 24th 18

What is causing this?

Although Good Friend International Holdings is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. Because of this, it is important to look beyond the final value of 2398’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that 2398’s ROCE has deteriorated from 14%, indicating the company’s capital returns have declined. With this, the current earnings of CN¥69m actually declined from CN¥105m whilst capital employed has increased due to a hike in the level of total assets employed , which means the company’s ROCE has shrunk as a result of falling earnings and simultaneous increases in capital requirements.

Next Steps

ROCE for 2398 investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and management ability. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.

  1. Future Outlook: What are well-informed industry analysts predicting for 2398’s future growth? Take a look at our free research report of analyst consensus for 2398’s outlook.
  2. Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for Good Friend International Holdings’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.