Capital Environment Holdings (HKG:3989) Shareholders Will Want The ROCE Trajectory To Continue

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Speaking of which, we noticed some great changes in Capital Environment Holdings' (HKG:3989) returns on capital, so let's have a look.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Capital Environment Holdings:

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

0.081 = CN¥1.3b ÷ (CN¥24b - CN¥8.5b) (Based on the trailing twelve months to December 2020).

Thus, Capital Environment Holdings has an ROCE of 8.1%. On its own, that's a low figure but it's around the 9.7% average generated by the Commercial Services industry.

View our latest analysis for Capital Environment 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're interested in investigating Capital Environment Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Capital Environment Holdings Tell Us?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. Over the last five years, returns on capital employed have risen substantially to 8.1%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 106%. So we're very much inspired by what we're seeing at Capital Environment Holdings thanks to its ability to profitably reinvest capital.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 35% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Key Takeaway

To sum it up, Capital Environment Holdings has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 48% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you'd like to know about the risks facing Capital Environment Holdings, we've discovered 1 warning sign that you should be aware of.

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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