Capital Allocation Trends At Golden Faith Group Holdings (HKG:2863) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think Golden Faith Group Holdings (HKG:2863) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Golden Faith Group Holdings is:

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

0.076 = HK$21m ÷ (HK$309m - HK$35m) (Based on the trailing twelve months to March 2021).

Thus, Golden Faith Group Holdings has an ROCE of 7.6%. In absolute terms, that's a low return but it's around the Construction industry average of 9.1%.

View our latest analysis for Golden Faith Group 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 Golden Faith Group Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Golden Faith Group Holdings' ROCE Trending?

When we looked at the ROCE trend at Golden Faith Group Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 59%, but since then they've fallen to 7.6%. 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, Golden Faith Group Holdings has done well to pay down its current liabilities to 11% 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 Golden Faith Group Holdings' ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Golden Faith Group Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 42% over the last three years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we found 4 warning signs for Golden Faith Group Holdings (1 can't be ignored) you should be aware of.

While Golden Faith Group Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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