Hong Kong Johnson Holdings (HKG:1955) Will Be Hoping To Turn Its Returns On Capital Around

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Hong Kong Johnson Holdings (HKG:1955), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Hong Kong Johnson Holdings, this is the formula:

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

0.32 = HK$173m ÷ (HK$961m - HK$415m) (Based on the trailing twelve months to March 2021).

So, Hong Kong Johnson Holdings has an ROCE of 32%. In absolute terms that's a great return and it's even better than the Commercial Services industry average of 9.1%.

View our latest analysis for Hong Kong Johnson 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 Hong Kong Johnson 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 Hong Kong Johnson Holdings doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 41% where it was four years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Hong Kong Johnson Holdings has decreased its current liabilities to 43% 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. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Hong Kong Johnson Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Hong Kong Johnson Holdings is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 105% to shareholders in the last year. 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.

Like most companies, Hong Kong Johnson Holdings does come with some risks, and we've found 4 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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