Asia Cement (China) Holdings (HKG:743) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Asia Cement (China) Holdings (HKG:743) 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)?

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 Asia Cement (China) Holdings, this is the formula:

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

0.03 = CN¥563m ÷ (CN¥21b - CN¥2.2b) (Based on the trailing twelve months to December 2022).

Therefore, Asia Cement (China) Holdings has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Basic Materials industry average of 5.8%.

See our latest analysis for Asia Cement (China) Holdings

Above you can see how the current ROCE for Asia Cement (China) Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Asia Cement (China) Holdings here for free.

What Can We Tell From Asia Cement (China) Holdings' ROCE Trend?

In terms of Asia Cement (China) Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.0% from 10% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Asia Cement (China) Holdings has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Asia Cement (China) Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 52% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Asia Cement (China) Holdings does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) 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.

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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.