Huaxi Holdings (HKG:1689) Will Be Hoping To Turn Its Returns On Capital Around

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Although, when we looked at Huaxi Holdings (HKG:1689), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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 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).

Therefore, Huaxi Holdings has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Packaging industry average of 8.2%.

Check out the opportunities and risks within the HK Packaging industry.

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're interested in investigating Huaxi Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Huaxi Holdings' ROCE Trend?

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. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

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. Without this increase, it's likely that ROCE would be even lower than 1.0%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Huaxi Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 57% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a final note, we've found 1 warning sign for Huaxi Holdings that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.