Wing Fung Group Asia (HKG:8526) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Wing Fung Group Asia (HKG:8526), we don't think it's current trends fit the mold of a multi-bagger.

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

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 Wing Fung Group Asia, this is the formula:

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

0.19 = HK$24m ÷ (HK$205m - HK$77m) (Based on the trailing twelve months to June 2021).

So, Wing Fung Group Asia has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 7.8% it's much better.

View our latest analysis for Wing Fung Group Asia

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 Wing Fung Group Asia 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

In terms of Wing Fung Group Asia's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 42% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Wing Fung Group Asia has decreased its current liabilities to 38% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Wing Fung Group Asia is reinvesting for growth and has higher sales as a result. Despite these promising trends, the stock has collapsed 79% over the last three years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Wing Fung Group Asia (of which 1 is significant!) that you should know about.

While Wing Fung Group Asia 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.

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.

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