Hong Wei (Asia) Holdings' (HKG:8191) Returns On Capital Tell Us There Is Reason To Feel Uneasy

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. And from a first read, things don't look too good at Hong Wei (Asia) Holdings (HKG:8191), so let's see why.

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. 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)

0.0065 = HK$2.6m ÷ (HK$716m - HK$310m) (Based on the trailing twelve months to March 2021).

So, Hong Wei (Asia) Holdings has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Forestry industry average of 7.6%.

See our latest analysis for Hong Wei (Asia) Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hong Wei (Asia) Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Hong Wei (Asia) Holdings, check out these free graphs here.

So How Is Hong Wei (Asia) Holdings' ROCE Trending?

In terms of Hong Wei (Asia) Holdings' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 7.1% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Hong Wei (Asia) Holdings becoming one if things continue as they have.

On a side note, Hong Wei (Asia) Holdings' current liabilities are still rather high at 43% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 66% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Hong Wei (Asia) Holdings (of which 2 can't be ignored!) that 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. 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.
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