The Trends At China Hongguang Holdings (HKG:8646) That You Should Know About

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. 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)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.13 = CN¥20m ÷ (CN¥217m - CN¥58m) (Based on the trailing twelve months to September 2020).

So, China Hongguang Holdings has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Building industry average of 12%.

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

How Are Returns 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 48% over the last two years. 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.

On a related note, China Hongguang Holdings has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. 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, we're somewhat concerned by China Hongguang Holdings' diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 55% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we found 4 warning signs for China Hongguang Holdings (1 is a bit unpleasant) 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. 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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