Returns On Capital Signal Tricky Times Ahead For Golden Faith Group Holdings (HKG:2863)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Golden Faith Group Holdings (HKG:2863), it didn't seem to tick all of these boxes.

Understanding 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. Analysts use this formula to calculate it for Golden Faith Group Holdings:

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

0.07 = HK$21m ÷ (HK$326m - HK$24m) (Based on the trailing twelve months to March 2022).

So, Golden Faith Group Holdings has an ROCE of 7.0%. Even though it's in line with the industry average of 7.1%, it's still a low return by itself.

See 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're interested in investigating Golden Faith Group Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Golden Faith Group Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 32%, but since then they've fallen to 7.0%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Golden Faith Group Holdings has done well to pay down its current liabilities to 7.4% 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.

The Bottom Line On Golden Faith Group Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Golden Faith Group Holdings. And there could be an opportunity here if other metrics look good too, because the stock has declined 53% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Golden Faith Group Holdings, we've spotted 4 warning signs, and 2 of them are a bit unpleasant.

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.

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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.