Here's What To Make Of Sunfonda Group Holdings' (HKG:1771) Decelerating Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Sunfonda Group Holdings' (HKG:1771) ROCE trend, we were pretty happy with what we saw.

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. To calculate this metric for Sunfonda Group Holdings, this is the formula:

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

0.11 = CN¥360m ÷ (CN¥6.2b - CN¥3.0b) (Based on the trailing twelve months to June 2022).

Thus, Sunfonda Group Holdings has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.

Our analysis indicates that 1771 is potentially undervalued!

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

So How Is Sunfonda Group Holdings' ROCE Trending?

While the current returns on capital are decent, they haven't changed much. The company has consistently earned 11% for the last five years, and the capital employed within the business has risen 70% in that time. Since 11% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On a side note, Sunfonda 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Sunfonda Group Holdings' ROCE

To sum it up, Sunfonda Group Holdings has simply been reinvesting capital steadily, at those decent rates of return. Despite the good fundamentals, total returns from the stock have been virtually flat over the last five years. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

One more thing: We've identified 4 warning signs with Sunfonda Group Holdings (at least 2 which are a bit unpleasant) , and understanding these would certainly be useful.

While Sunfonda Group Holdings 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. 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.