There Are Reasons To Feel Uneasy About China Hongguang Holdings' (HKG:8646) Returns On Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 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. 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)

0.16 = CN¥44m ÷ (CN¥407m - CN¥125m) (Based on the trailing twelve months to December 2022).

Therefore, China Hongguang Holdings has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Building industry average of 7.0% it's much better.

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

SWOT Analysis for China Hongguang Holdings

What Can We Tell From China Hongguang Holdings' ROCE Trend?

On the surface, the trend of ROCE at China Hongguang Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 43% over the last five years. 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 related note, China Hongguang Holdings has decreased its current liabilities to 31% 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.

In Conclusion...

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 57% in the last three years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing: We've identified 4 warning signs with China Hongguang Holdings (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

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.