Capital Allocation Trends At REF Holdings (HKG:1631) Aren't Ideal

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating REF Holdings (HKG:1631), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 REF Holdings is:

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

0.10 = HK$17m ÷ (HK$210m - HK$46m) (Based on the trailing twelve months to December 2021).

Therefore, REF Holdings has an ROCE of 10%. On its own, that's a standard return, however it's much better than the 8.0% generated by the Commercial Services industry.

View our latest analysis for REF Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for REF Holdings' ROCE against it's prior returns. If you'd like to look at how REF Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From REF Holdings' ROCE Trend?

When we looked at the ROCE trend at REF Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 10% from 52% five years ago. However it looks like REF Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

In summary, REF 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 28% in the last five 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.

If you want to know some of the risks facing REF Holdings we've found 6 warning signs (2 are significant!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.