Some Investors May Be Worried About Ka Shui International Holdings' (HKG:822) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Ka Shui International Holdings (HKG:822), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Ka Shui International Holdings is:

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

0.086 = HK$112m ÷ (HK$1.7b - HK$428m) (Based on the trailing twelve months to June 2022).

Thus, Ka Shui International Holdings has an ROCE of 8.6%. On its own that's a low return, but compared to the average of 6.9% generated by the Machinery industry, it's much better.

Check out our latest analysis for Ka Shui International 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 Ka Shui International 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 Ka Shui International Holdings' ROCE Trending?

When we looked at the ROCE trend at Ka Shui International Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.6% from 15% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Ka Shui International Holdings has done well to pay down its current liabilities to 25% of total assets. That could partly explain why the ROCE has dropped. 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 Ka Shui International Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Ka Shui International Holdings' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 29% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing to note, we've identified 2 warning signs with Ka Shui International Holdings and understanding them should be part of your investment process.

While Ka Shui International 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. 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.