Alpha Era International Holdings (HKG:8406) Is Reinvesting At Lower Rates Of Return

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Looking at Alpha Era International Holdings (HKG:8406), it does have a high ROCE right now, but lets see how returns are trending.

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 Alpha Era International Holdings:

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

0.26 = CN¥37m ÷ (CN¥194m - CN¥51m) (Based on the trailing twelve months to September 2020).

So, Alpha Era International Holdings has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Leisure industry average of 9.1%.

See our latest analysis for Alpha Era International Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Alpha Era International Holdings' ROCE against it's prior returns. If you're interested in investigating Alpha Era International Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Alpha Era International Holdings' ROCE Trend?

In terms of Alpha Era International Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 34% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Alpha Era International Holdings has decreased its current liabilities to 26% 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.

The Bottom Line On Alpha Era International Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Alpha Era International Holdings is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 21% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Alpha Era International Holdings does come with some risks, and we've found 3 warning signs that you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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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