Returns On Capital At China Hongguang Holdings (HKG:8646) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at China Hongguang Holdings (HKG:8646), it didn't seem to tick all of these boxes.

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. 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).

Therefore, 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

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 China Hongguang Holdings' past further, check out this free graph covering China Hongguang Holdings' past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of China Hongguang Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 43%, but since then they've fallen to 14%. 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 26% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From China Hongguang Holdings' ROCE

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 appear hesitant that the trends will pick up because the stock has fallen 20% in the last three years. Therefore based on the analysis done in this article, we don't think China Hongguang Holdings has the makings of a multi-bagger.

Like most companies, China Hongguang Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.

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.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com