China Hongguang Holdings (HKG:8646) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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 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.

What Is Return On Capital Employed (ROCE)?

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 China Hongguang Holdings, this is the formula:

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

0.14 = CN¥44m ÷ (CN¥439m - CN¥114m) (Based on the trailing twelve months to December 2023).

So, China Hongguang Holdings has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Building industry average of 13%.

See 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'd like to look at how China Hongguang Holdings has performed in the past in other metrics, you can view this free graph of China Hongguang Holdings' past earnings, revenue and cash flow.

So How Is China Hongguang Holdings' ROCE Trending?

When we looked at the ROCE trend at China Hongguang Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 43% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 related note, China Hongguang Holdings has decreased its current liabilities to 26% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

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 in the last three years, the stock has given away 35% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think China Hongguang Holdings has the makings of a multi-bagger.

On a separate note, we've found 2 warning signs for China Hongguang Holdings you'll probably want to know about.

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.