Capital Allocation Trends At Smart Globe Holdings (HKG:1481) Aren't Ideal

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, while the ROCE is currently high for Smart Globe Holdings (HKG:1481), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Smart Globe Holdings, this is the formula:

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

0.22 = HK$26m ÷ (HK$143m - HK$27m) (Based on the trailing twelve months to September 2020).

Thus, Smart Globe Holdings has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 9.7% earned by companies in a similar industry.

Check out our latest analysis for Smart Globe 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'd like to look at how Smart Globe Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Smart Globe Holdings, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 47% where it was four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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, Smart Globe Holdings has decreased its current liabilities to 19% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Smart Globe Holdings' ROCE

To conclude, we've found that Smart Globe Holdings is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 41% over the last three years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a separate note, we've found 3 warning signs for Smart Globe Holdings you'll probably want to know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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