Gudou Holdings (HKG:8308) Will Be Hoping To Turn Its Returns On Capital Around

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Gudou Holdings (HKG:8308) and its ROCE trend, we weren't exactly thrilled.

Understanding 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. The formula for this calculation on Gudou Holdings is:

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

0.02 = CN¥17m ÷ (CN¥1.2b - CN¥314m) (Based on the trailing twelve months to March 2021).

So, Gudou Holdings has an ROCE of 2.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 2.2%.

View our latest analysis for Gudou Holdings

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

What The Trend Of ROCE Can Tell Us

In terms of Gudou Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 3.2%, but since then they've fallen to 2.0%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Gudou Holdings has decreased its current liabilities to 27% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Gudou Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Unsurprisingly then, the stock has dived 72% over the last three years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Gudou Holdings (of which 1 doesn't sit too well with us!) that you should know about.

While Gudou 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.
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