Capital Allocation Trends At Chi Ho Development Holdings (HKG:8423) Aren't Ideal

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Chi Ho Development Holdings (HKG:8423) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. Analysts use this formula to calculate it for Chi Ho Development Holdings:

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

0.10 = HK$15m ÷ (HK$344m - HK$194m) (Based on the trailing twelve months to June 2023).

Thus, Chi Ho Development Holdings has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 6.5% it's much better.

View our latest analysis for Chi Ho Development Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Chi Ho Development Holdings' ROCE against it's prior returns. If you'd like to look at how Chi Ho Development Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Chi Ho Development Holdings Tell Us?

On the surface, the trend of ROCE at Chi Ho Development Holdings doesn't inspire confidence. Around five years ago the returns on capital were 32%, but since then they've fallen to 10%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Chi Ho Development Holdings' current liabilities are still rather high at 57% of total assets. 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 Chi Ho Development Holdings' ROCE

While returns have fallen for Chi Ho Development Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. But since the stock has dived 95% in the last five years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

One more thing: We've identified 3 warning signs with Chi Ho Development Holdings (at least 2 which are a bit concerning) , and understanding them would certainly be useful.

While Chi Ho Development 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.