Some Investors May Be Worried About Honghua Group's (HKG:196) Returns On Capital

When researching a stock for investment, what can tell us that the company is in decline? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Honghua Group (HKG:196), so let's see why.

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 Honghua Group is:

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

0.000034 = CN¥186k ÷ (CN¥13b - CN¥7.7b) (Based on the trailing twelve months to June 2023).

Thus, Honghua Group has an ROCE of 0.003%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 7.9%.

See our latest analysis for Honghua Group

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

What Can We Tell From Honghua Group's ROCE Trend?

In terms of Honghua Group's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 3.7%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Honghua Group becoming one if things continue as they have.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 59%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. This could explain why the stock has sunk a total of 78% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Like most companies, Honghua Group does come with some risks, and we've found 2 warning signs that you should be aware of.

While Honghua Group 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.