Returns On Capital Signal Tricky Times Ahead For AK Medical Holdings (HKG:1789)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 AK Medical Holdings (HKG:1789), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for AK Medical Holdings, this is the formula:

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

0.047 = CN¥105m ÷ (CN¥2.7b - CN¥418m) (Based on the trailing twelve months to June 2022).

So, AK Medical Holdings has an ROCE of 4.7%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 11%.

Check out our latest analysis for AK Medical Holdings

In the above chart we have measured AK Medical Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is AK Medical Holdings' ROCE Trending?

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. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, AK Medical Holdings has done well to pay down its current liabilities to 16% 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. 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 AK Medical Holdings' ROCE

We're a bit apprehensive about AK Medical Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 151%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for AK Medical Holdings you'll probably want to know about.

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.

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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.