Be Wary Of Hong Wei (Asia) Holdings (HKG:8191) And Its Returns On Capital

What financial metrics can indicate to us that a company is maturing or even in decline? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after we looked into Hong Wei (Asia) Holdings (HKG:8191), the trends above didn't look too great.

Return On Capital Employed (ROCE): What is it?

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 Hong Wei (Asia) Holdings is:

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

0.0081 = HK$3.3m ÷ (HK$752m - HK$342m) (Based on the trailing twelve months to June 2021).

So, Hong Wei (Asia) Holdings has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Forestry industry average of 7.9%.

View our latest analysis for Hong Wei (Asia) 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 Hong Wei (Asia) Holdings, check out these free graphs here.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Hong Wei (Asia) Holdings. About five years ago, returns on capital were 7.8%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. If these trends continue, we wouldn't expect Hong Wei (Asia) Holdings to turn into a multi-bagger.

Another thing to note, Hong Wei (Asia) Holdings has a high ratio of current liabilities to total assets of 45%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. This could explain why the stock has sunk a total of 78% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Hong Wei (Asia) Holdings does have some risks, we noticed 4 warning signs (and 3 which are significant) we think you should know about.

While Hong Wei (Asia) Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.

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