Returns On Capital At Huaxi Holdings (HKG:1689) Paint A Concerning Picture

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Huaxi Holdings (HKG:1689) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Huaxi Holdings, this is the formula:

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

0.12 = HK$57m ÷ (HK$733m - HK$270m) (Based on the trailing twelve months to December 2021).

Therefore, Huaxi Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Packaging industry average of 9.9% it's much better.

View 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'd like to look at how Huaxi Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Huaxi Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 18%, but since then they've fallen to 12%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Huaxi Holdings' current liabilities have increased over the last five years to 37% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 12%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Huaxi Holdings' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 2.4% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 2 warning signs facing Huaxi Holdings that you might find interesting.

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.