Grace Wine Holdings (HKG:8146) Might Be Having Difficulty Using Its Capital Effectively

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Grace Wine Holdings (HKG:8146), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Grace Wine Holdings is:

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

0.035 = CN¥9.2m ÷ (CN¥272m - CN¥13m) (Based on the trailing twelve months to September 2021).

So, Grace Wine Holdings has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Beverage industry average of 10%.

View our latest analysis for Grace Wine 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'd like to look at how Grace Wine Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Grace Wine Holdings Tell Us?

When we looked at the ROCE trend at Grace Wine Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.5% from 14% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Grace Wine Holdings has done well to pay down its current liabilities to 4.9% of total assets. So we could link some of this to the decrease in ROCE. 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.

Our Take On Grace Wine Holdings' ROCE

While returns have fallen for Grace Wine Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 48% 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.

Grace Wine Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is concerning...

While Grace Wine Holdings 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.