Capital Allocation Trends At Sunray Engineering Group (HKG:8616) Aren't Ideal

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Sunray Engineering Group (HKG:8616) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Sunray Engineering Group:

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

0.09 = HK$16m ÷ (HK$221m - HK$47m) (Based on the trailing twelve months to March 2021).

Thus, Sunray Engineering Group has an ROCE of 9.0%. On its own that's a low return, but compared to the average of 7.4% generated by the Construction industry, it's much better.

See our latest analysis for Sunray Engineering Group

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're interested in investigating Sunray Engineering Group's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Sunray Engineering Group, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 9.0% from 21% three 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.

What We Can Learn From Sunray Engineering Group's ROCE

In summary, we're somewhat concerned by Sunray Engineering Group's diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last year. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Sunray Engineering Group, we've spotted 4 warning signs, and 2 of them don't sit too well with us.

While Sunray Engineering Group 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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