Grace Wine Holdings' (HKG:8146) Returns On Capital Not Reflecting Well On The Business

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Grace Wine Holdings (HKG:8146), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Grace Wine Holdings:

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

0.04 = CN¥10m ÷ (CN¥279m - CN¥23m) (Based on the trailing twelve months to March 2021).

So, Grace Wine Holdings has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Beverage industry average of 9.5%.

Check out our latest analysis for Grace Wine Holdings

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

The Trend Of ROCE

When we looked at the ROCE trend at Grace Wine Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 21% over the last five years. 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 side note, Grace Wine Holdings has done well to pay down its current liabilities to 8.2% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Grace Wine Holdings is reinvesting for growth and has higher sales as a result. But since the stock has dived 82% in the last three years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

Grace Wine Holdings does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.

While Grace Wine 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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