Sinotruk (Hong Kong) (HKG:3808) Might Be Having Difficulty Using Its Capital Effectively

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Sinotruk (Hong Kong) (HKG:3808), 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 Sinotruk (Hong Kong), this is the formula:

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

0.038 = CN¥1.6b ÷ (CN¥101b - CN¥58b) (Based on the trailing twelve months to June 2022).

So, Sinotruk (Hong Kong) has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.9%.

View our latest analysis for Sinotruk (Hong Kong)

Above you can see how the current ROCE for Sinotruk (Hong Kong) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Sinotruk (Hong Kong) here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Sinotruk (Hong Kong), we didn't gain much confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 3.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 separate but related note, it's important to know that Sinotruk (Hong Kong) has a current liabilities to total assets ratio of 57%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Sinotruk (Hong Kong)'s ROCE

We're a bit apprehensive about Sinotruk (Hong Kong) because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 51% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you'd like to know more about Sinotruk (Hong Kong), we've spotted 3 warning signs, and 1 of them can't be ignored.

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.