Some Investors May Be Worried About Inke's (HKG:3700) Returns On Capital

Simply Wall St
January 23, 2022
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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Inke (HKG:3700), 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. Analysts use this formula to calculate it for Inke:

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

0.031 = CN¥119m ÷ (CN¥4.8b - CN¥955m) (Based on the trailing twelve months to June 2021).

Thus, Inke has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Interactive Media and Services industry average of 7.0%.

View our latest analysis for Inke

SEHK:3700 Return on Capital Employed January 23rd 2022

In the above chart we have measured Inke's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Inke here for free.

What Does the ROCE Trend For Inke Tell Us?

When we looked at the ROCE trend at Inke, we didn't gain much confidence. Around five years ago the returns on capital were 58%, but since then they've fallen to 3.1%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Inke has decreased its current liabilities to 20% 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

While returns have fallen for Inke in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 1 warning sign for Inke you'll probably want to know about.

While Inke 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.

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