Here's What's Concerning About Huaxi Holdings' (HKG:1689) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Huaxi Holdings (HKG:1689) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Huaxi Holdings is:

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

0.01 = HK$4.5m ÷ (HK$636m - HK$201m) (Based on the trailing twelve months to June 2022).

Thus, Huaxi Holdings has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Packaging industry average of 9.6%.

Check out our latest analysis for Huaxi Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Huaxi Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Huaxi Holdings, check out these free graphs here.

So How Is Huaxi Holdings' ROCE Trending?

When we looked at the ROCE trend at Huaxi Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% 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, Huaxi Holdings' current liabilities have increased over the last five years to 32% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line On Huaxi Holdings' ROCE

We're a bit apprehensive about Huaxi Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 43% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Huaxi Holdings does have some risks though, and we've spotted 1 warning sign for Huaxi Holdings that you might be interested in.

While Huaxi 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.