Some Investors May Be Worried About Prosper Construction Holdings' (HKG:6816) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Prosper Construction Holdings (HKG:6816), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

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. To calculate this metric for Prosper Construction Holdings, this is the formula:

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

0.048 = HK$50m ÷ (HK$2.7b - HK$1.6b) (Based on the trailing twelve months to June 2021).

Therefore, Prosper Construction Holdings has an ROCE of 4.8%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 8.7%.

See our latest analysis for Prosper Construction Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Prosper Construction Holdings' ROCE against it's prior returns. If you're interested in investigating Prosper Construction Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Prosper Construction Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.8% from 43% five years ago. 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, Prosper Construction Holdings' current liabilities have increased over the last five years to 61% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On Prosper Construction Holdings' ROCE

While returns have fallen for Prosper Construction Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Prosper Construction Holdings does have some risks, we noticed 5 warning signs (and 3 which are significant) we think you should know about.

While Prosper Construction Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.