Capital Allocation Trends At AK Medical Holdings (HKG:1789) Aren't Ideal

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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 briefly looking over the numbers, we don't think AK Medical Holdings (HKG:1789) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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 AK Medical Holdings:

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

0.15 = CN¥315m ÷ (CN¥2.6b - CN¥411m) (Based on the trailing twelve months to June 2021).

So, AK Medical Holdings has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 10% generated by the Medical Equipment industry.

View our latest analysis for AK Medical Holdings

Above you can see how the current ROCE for AK Medical Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for AK Medical Holdings.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at AK Medical Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 34% over the last five years. However it looks like AK Medical Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, AK Medical Holdings has done well to pay down its current liabilities to 16% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

To conclude, we've found that AK Medical Holdings is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 110% return in the last three years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One final note, you should learn about the 2 warning signs we've spotted with AK Medical Holdings (including 1 which makes us a bit uncomfortable) .

While AK Medical 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.

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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