The Returns On Capital At GHW International (HKG:9933) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at GHW International (HKG:9933) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on GHW International is:

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

0.079 = CN¥30m ÷ (CN¥1.0b - CN¥646m) (Based on the trailing twelve months to December 2020).

So, GHW International has an ROCE of 7.9%. On its own, that's a low figure but it's around the 9.5% average generated by the Chemicals industry.

See our latest analysis for GHW International

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 GHW International, check out these free graphs here.

What Can We Tell From GHW International's ROCE Trend?

On the surface, the trend of ROCE at GHW International doesn't inspire confidence. Around four years ago the returns on capital were 22%, but since then they've fallen to 7.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, GHW International has decreased its current liabilities to 63% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

To conclude, we've found that GHW International is reinvesting in the business, but returns have been falling. Since the stock has declined 33% over the last year, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing: We've identified 4 warning signs with GHW International (at least 2 which can't be ignored) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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