Be Wary Of Zhixin Group Holding (HKG:2187) And Its Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Zhixin Group Holding (HKG:2187), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Zhixin Group Holding, this is the formula:

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

0.017 = CN¥11m ÷ (CN¥1.4b - CN¥745m) (Based on the trailing twelve months to December 2022).

Thus, Zhixin Group Holding has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Basic Materials industry average of 3.9%.

Check out our latest analysis for Zhixin Group Holding

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

What Does the ROCE Trend For Zhixin Group Holding Tell Us?

In terms of Zhixin Group Holding's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 14% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Zhixin Group Holding has done well to pay down its current liabilities to 54% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Zhixin Group Holding's ROCE

We're a bit apprehensive about Zhixin Group Holding because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 214%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Zhixin Group Holding does have some risks, we noticed 5 warning signs (and 4 which shouldn't be ignored) we think you should know about.

While Zhixin Group Holding isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.