Here's What's Concerning About C Cheng Holdings' (HKG:1486) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think C Cheng Holdings (HKG:1486) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on C Cheng Holdings is:

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

0.014 = HK$8.5m ÷ (HK$904m - HK$306m) (Based on the trailing twelve months to December 2021).

Thus, C Cheng Holdings has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 15%.

View our latest analysis for C Cheng 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 C Cheng 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

On the surface, the trend of ROCE at C Cheng Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, C Cheng Holdings has decreased its current liabilities to 34% 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.

What We Can Learn From C Cheng Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for C Cheng Holdings. These growth trends haven't led to growth returns though, since the stock has fallen 69% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One final note, you should learn about the 2 warning signs we've spotted with C Cheng Holdings (including 1 which is significant) .

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.