Binjiang Service Group (HKG:3316) May Have Issues Allocating Its Capital

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Binjiang Service Group (HKG:3316), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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 Binjiang Service Group, this is the formula:

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

0.35 = CN¥303m ÷ (CN¥1.6b - CN¥701m) (Based on the trailing twelve months to June 2021).

Thus, Binjiang Service Group has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Commercial Services industry average of 8.5%.

See our latest analysis for Binjiang Service Group

Above you can see how the current ROCE for Binjiang Service Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Binjiang Service Group.

What Does the ROCE Trend For Binjiang Service Group Tell Us?

On the surface, the trend of ROCE at Binjiang Service Group doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 50% where it was five 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Binjiang Service Group has done well to pay down its current liabilities to 45% 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. Keep in mind 45% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Binjiang Service Group. Furthermore the stock has climbed 60% over the last year, it would appear that investors are upbeat about the future. 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.

Binjiang Service Group does have some risks though, and we've spotted 1 warning sign for Binjiang Service Group that you might be interested in.

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.

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.

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