Activation Group Holdings (HKG:9919) Will Be Hoping To Turn Its Returns On Capital Around

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Activation Group Holdings (HKG:9919), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Activation Group Holdings:

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

0.17 = CN¥72m ÷ (CN¥576m - CN¥158m) (Based on the trailing twelve months to June 2022).

So, Activation Group Holdings has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 5.0% generated by the Media industry.

Check out our latest analysis for Activation Group Holdings

Above you can see how the current ROCE for Activation Group Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Activation Group Holdings here for free.

What Does the ROCE Trend For Activation Group Holdings Tell Us?

In terms of Activation Group Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 32% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Activation Group Holdings has done well to pay down its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Activation Group Holdings' ROCE

In summary, we're somewhat concerned by Activation Group Holdings' diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last yearthe stock has delivered a respectable 12% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing to note, we've identified 1 warning sign with Activation Group Holdings and understanding it should be part of your investment process.

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. 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.