Kidztech Holdings' (HKG:6918) Returns On Capital Not Reflecting Well On The Business

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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Kidztech Holdings (HKG:6918) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Kidztech Holdings, this is the formula:

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

0.076 = CN¥35m ÷ (CN¥781m - CN¥329m) (Based on the trailing twelve months to December 2021).

Thus, Kidztech Holdings has an ROCE of 7.6%. In absolute terms, that's a low return, but it's much better than the Leisure industry average of 3.6%.

See our latest analysis for Kidztech 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 want to delve into the historical earnings, revenue and cash flow of Kidztech Holdings, check out these free graphs here.

What Can We Tell From Kidztech Holdings' ROCE Trend?

When we looked at the ROCE trend at Kidztech Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 26% over the last five years. However it looks like Kidztech 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.

On a separate but related note, it's important to know that Kidztech Holdings has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. 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...

Bringing it all together, while we're somewhat encouraged by Kidztech Holdings' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 30% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 2 warning signs we've spotted with Kidztech Holdings (including 1 which doesn't sit too well with us) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.