Here's What's Concerning About Activation Group Holdings' (HKG:9919) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after briefly looking over the numbers, we don't think Activation Group Holdings (HKG:9919) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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 Activation Group Holdings is:

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

0.11 = CN¥40m ÷ (CN¥711m - CN¥348m) (Based on the trailing twelve months to December 2022).

Therefore, Activation Group Holdings has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Media industry average of 10.0%.

Check out our latest analysis for Activation Group Holdings

In the above chart we have measured Activation Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Activation Group Holdings.

The Trend Of ROCE

When we looked at the ROCE trend at Activation Group Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 29% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Activation Group Holdings' current liabilities are still rather high at 49% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Activation Group Holdings' ROCE

We're a bit apprehensive about Activation Group Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 104% over the last three years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we've found 3 warning signs for Activation Group Holdings that we think you should be aware of.

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.