Shenzhou International Group Holdings' (HKG:2313) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Shenzhou International Group Holdings (HKG:2313) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Shenzhou International Group Holdings:

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

0.10 = CN¥3.2b ÷ (CN¥43b - CN¥13b) (Based on the trailing twelve months to June 2022).

Therefore, Shenzhou International Group Holdings has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Luxury industry average of 11%.

View our latest analysis for Shenzhou International Group Holdings

In the above chart we have measured Shenzhou International Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shenzhou International Group Holdings here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Shenzhou International Group Holdings doesn't inspire confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 10%. However it looks like Shenzhou International Group Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 30%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 10%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shenzhou International Group Holdings' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 28% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing to note, we've identified 1 warning sign with Shenzhou International Group Holdings and understanding it should be part of your investment process.

While Shenzhou International Group Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.