Huaxi Holdings (HKG:1689) Knows How To Allocate Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. With that in mind, the ROCE of Huaxi Holdings (HKG:1689) looks attractive right now, so lets see what the trend of returns can tell us.

Return On Capital Employed (ROCE): What is it?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)

0.20 = HK$100m ÷ (HK$731m - HK$243m) (Based on the trailing twelve months to June 2021).

So, Huaxi Holdings has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Packaging industry average of 12%.

Check out our latest analysis for Huaxi Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Huaxi Holdings, check out these free graphs here.

The Trend Of ROCE

We'd be pretty happy with returns on capital like Huaxi Holdings. The company has employed 58% more capital in the last five years, and the returns on that capital have remained stable at 20%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 33% of total assets, this reported ROCE would probably be less than20% because total capital employed would be higher.The 20% ROCE could be even lower if current liabilities weren't 33% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

The Bottom Line On Huaxi Holdings' ROCE

In short, we'd argue Huaxi Holdings has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. In light of this, the stock has only gained 29% over the last five years for shareholders who have owned the stock in this period. So to determine if Huaxi Holdings is a multi-bagger going forward, we'd suggest digging deeper into the company's other fundamentals.

On a final note, we found 3 warning signs for Huaxi Holdings (1 shouldn't be ignored) you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.