Here's What To Make Of Capital Environment Holdings' (HKG:3989) Decelerating Rates Of Return

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think Capital Environment Holdings (HKG:3989) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. 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)

0.082 = CN¥1.5b ÷ (CN¥31b - CN¥12b) (Based on the trailing twelve months to June 2022).

Thus, Capital Environment Holdings has an ROCE of 8.2%. Even though it's in line with the industry average of 8.2%, it's still a low return by itself.

Check out the opportunities and risks within the HK Commercial Services industry.

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 Capital Environment Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

The returns on capital haven't changed much for Capital Environment Holdings in recent years. The company has consistently earned 8.2% for the last five years, and the capital employed within the business has risen 228% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a side note, Capital Environment Holdings' current liabilities are still rather high at 41% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

As we've seen above, Capital Environment Holdings' returns on capital haven't increased but it is reinvesting in the business. Since the stock has declined 50% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Capital Environment Holdings has the makings of a multi-bagger.

On a final note, we found 2 warning signs for Capital Environment Holdings (1 is a bit unpleasant) you should be aware of.

While Capital Environment 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.