China Hongqiao Group (HKG:1378) Could Be Struggling To Allocate Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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 the company is producing less profit from its investments and its total assets are decreasing. On that note, looking into China Hongqiao Group (HKG:1378), we weren't too upbeat about how things were going.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on China Hongqiao Group is:

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

0.10 = CN¥12b ÷ (CN¥186b - CN¥71b) (Based on the trailing twelve months to December 2022).

So, China Hongqiao Group has an ROCE of 10%. On its own, that's a standard return, however it's much better than the 8.3% generated by the Metals and Mining industry.

Check out our latest analysis for China Hongqiao Group

In the above chart we have measured China Hongqiao Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for China Hongqiao Group.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at China Hongqiao Group. About five years ago, returns on capital were 13%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect China Hongqiao Group to turn into a multi-bagger.

Our Take On China Hongqiao Group's ROCE

In summary, it's unfortunate that China Hongqiao Group is generating lower returns from the same amount of capital. However the stock has delivered a 61% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing China Hongqiao Group, we've discovered 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.