Greentown Management Holdings (HKG:9979) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. 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 Greentown Management Holdings (HKG:9979) 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?

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. To calculate this metric for Greentown Management Holdings, this is the formula:

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

0.18 = CN¥543m ÷ (CN¥5.2b - CN¥2.1b) (Based on the trailing twelve months to June 2021).

Therefore, Greentown Management Holdings has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 7.8% generated by the Construction industry.

View our latest analysis for Greentown Management Holdings

Above you can see how the current ROCE for Greentown Management Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Greentown Management Holdings here for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Greentown Management Holdings, we didn't gain much confidence. Over the last three years, returns on capital have decreased to 18% from 52% three years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Greentown Management Holdings has decreased its current liabilities to 40% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Greentown Management Holdings is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 8.2% over the last year, it would appear that investors are upbeat about the future. 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.

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

While Greentown Management Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.
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