Nan Hai (HKG:680) Is Looking To Continue Growing Its Returns On Capital

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. So when we looked at Nan Hai (HKG:680) and its trend of ROCE, we really liked what we saw.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Nan Hai, this is the formula:

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

0.073 = HK$1.2b ÷ (HK$44b - HK$27b) (Based on the trailing twelve months to December 2020).

Therefore, Nan Hai has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Entertainment industry average of 13%.

Check out our latest analysis for Nan Hai

Historical performance is a great place to start when researching a stock so above you can see the gauge for Nan Hai's ROCE against it's prior returns. If you're interested in investigating Nan Hai's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

We're glad to see that ROCE is heading in the right direction, even if it is still low at the moment. Over the last five years, returns on capital employed have risen substantially to 7.3%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 82%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 62% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

Our Take On Nan Hai's ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Nan Hai has. And since the stock has fallen 70% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing to note, we've identified 2 warning signs with Nan Hai and understanding these should be part of your investment process.

While Nan Hai 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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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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