Returns On Capital Signal Tricky Times Ahead For Diwang Industrial Holdings (HKG:1950)

Did you know there are some financial metrics that can provide clues of a potential 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Diwang Industrial Holdings (HKG:1950), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on Diwang Industrial Holdings is:

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

0.029 = CN¥7.9m ÷ (CN¥313m - CN¥43m) (Based on the trailing twelve months to December 2021).

So, Diwang Industrial Holdings has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 12%.

See our latest analysis for Diwang Industrial 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 Diwang Industrial Holdings, check out these free graphs here.

What Does the ROCE Trend For Diwang Industrial Holdings Tell Us?

In terms of Diwang Industrial Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 2.9% from 22% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Diwang Industrial Holdings has done well to pay down its current liabilities to 14% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Diwang Industrial Holdings is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 25% over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Diwang Industrial Holdings does have some risks, we noticed 3 warning signs (and 1 which is a bit concerning) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.