Creative China Holdings (HKG:8368) Is Very Good At Capital Allocation

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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Creative China Holdings (HKG:8368) looks great, so lets see what the trend can tell us.

What Is 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. To calculate this metric for Creative China Holdings, this is the formula:

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

0.32 = CN¥54m ÷ (CN¥364m - CN¥193m) (Based on the trailing twelve months to June 2023).

Therefore, Creative China Holdings has an ROCE of 32%. In absolute terms that's a great return and it's even better than the Entertainment industry average of 6.8%.

See our latest analysis for Creative China 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're interested in investigating Creative China Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

Creative China Holdings has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 32% which is a sight for sore eyes. Not only that, but the company is utilizing 168% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

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 53% 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.

The Key Takeaway

In summary, it's great to see that Creative China Holdings has managed to break into profitability and is continuing to reinvest in its business. Astute investors may have an opportunity here because the stock has declined 25% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

One final note, you should learn about the 4 warning signs we've spotted with Creative China Holdings (including 2 which don't sit too well with us) .

Creative China Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.