Investors Could Be Concerned With China Hongguang Holdings' (HKG:8646) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So while China Hongguang Holdings (HKG:8646) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. Analysts use this formula to calculate it for China Hongguang Holdings:

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

0.22 = CN¥47m ÷ (CN¥324m - CN¥113m) (Based on the trailing twelve months to December 2021).

Therefore, China Hongguang Holdings has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Building industry average of 11%.

View 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 want to delve into the historical earnings, revenue and cash flow of China Hongguang Holdings, check out these free graphs here.

What Does the ROCE Trend For China Hongguang Holdings Tell Us?

On the surface, the trend of ROCE at China Hongguang Holdings doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 43% where it was four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, China Hongguang Holdings has decreased its current liabilities to 35% 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. 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

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for China Hongguang Holdings. And the stock has followed suit returning a meaningful 40% to shareholders over the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you want to know some of the risks facing China Hongguang Holdings we've found 3 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

China Hongguang Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.