Be Wary Of Sheung Moon Holdings (HKG:8523) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Sheung Moon Holdings (HKG:8523) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Sheung Moon Holdings:

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

0.024 = HK$4.5m ÷ (HK$398m - HK$209m) (Based on the trailing twelve months to March 2022).

Therefore, Sheung Moon Holdings has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Construction industry average of 7.3%.

See our latest analysis for Sheung Moon Holdings

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Sheung Moon Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.4% from 34% five years ago. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 53%, which has impacted the ROCE. 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

From the above analysis, we find it rather worrisome that returns on capital and sales for Sheung Moon Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last three years have experienced a 69% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Sheung Moon Holdings does have some risks though, and we've spotted 3 warning signs for Sheung Moon Holdings that you might be interested in.

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.