Some Investors May Be Worried About Hong Kong Johnson Holdings' (HKG:1955) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. Although, when we looked at Hong Kong Johnson Holdings (HKG:1955), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on Hong Kong Johnson Holdings is:

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

0.18 = HK$112m ÷ (HK$1.2b - HK$526m) (Based on the trailing twelve months to September 2022).

Therefore, Hong Kong Johnson Holdings has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Commercial Services industry.

View our latest analysis for Hong Kong Johnson Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hong Kong Johnson Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hong Kong Johnson Holdings, check out these free graphs here.

How Are Returns Trending?

In terms of Hong Kong Johnson Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 34%, but since then they've fallen to 18%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Hong Kong Johnson Holdings has decreased its current liabilities to 45% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Hong Kong Johnson Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Hong Kong Johnson Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 85% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Hong Kong Johnson Holdings does have some risks though, and we've spotted 3 warning signs for Hong Kong Johnson Holdings that you might be interested in.

While Hong Kong Johnson 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.