Guan Chao Holdings (HKG:1872) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Guan Chao Holdings (HKG:1872) 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?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Guan Chao Holdings is:

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

0.079 = S$10.0m ÷ (S$155m - S$30m) (Based on the trailing twelve months to June 2023).

Thus, Guan Chao Holdings has an ROCE of 7.9%. In absolute terms, that's a low return but it's around the Specialty Retail industry average of 9.9%.

See our latest analysis for Guan Chao Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guan Chao Holdings' ROCE against it's prior returns. If you'd like to look at how Guan Chao Holdings has performed in the past in other metrics, you can view this free graph of Guan Chao Holdings' past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Guan Chao Holdings doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 7.9%. However it looks like Guan Chao Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Guan Chao Holdings has decreased its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Guan Chao Holdings' reinvestment in its own business, we're aware that returns are shrinking. Moreover, since the stock has crumbled 94% over the last five years, it appears investors are expecting the worst. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Like most companies, Guan Chao Holdings does come with some risks, and we've found 3 warning signs that 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.