China Hongguang Holdings (HKG:8646) Could Be Struggling To Allocate Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at China Hongguang Holdings (HKG:8646) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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. To calculate this metric for China Hongguang Holdings, this is the formula:

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

0.13 = CN¥25m ÷ (CN¥270m - CN¥88m) (Based on the trailing twelve months to June 2021).

Thus, China Hongguang Holdings has an ROCE of 13%. That's a pretty standard return and it's in line with the industry average of 13%.

Check out our latest analysis for China Hongguang Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Hongguang Holdings' ROCE against it's prior returns. If you're interested in investigating China Hongguang Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

In terms of China Hongguang Holdings' historical ROCE movements, the trend isn't fantastic. Around three years ago the returns on capital were 43%, but since then they've fallen to 13%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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, China Hongguang Holdings has done well to pay down its current liabilities to 32% 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. 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.

The Bottom Line

In summary, China Hongguang Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 72% over the last year. Therefore based on the analysis done in this article, we don't think China Hongguang Holdings has the makings of a multi-bagger.

If you'd like to know more about China Hongguang Holdings, we've spotted 3 warning signs, and 2 of them are a bit unpleasant.

While China Hongguang Holdings 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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