Guan Chao Holdings (HKG:1872) Will Will Want To Turn Around Its Return Trends

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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Guan Chao Holdings (HKG:1872), we don't think it's current trends fit the mold of a multi-bagger.

What is Return On Capital Employed (ROCE)?

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)

0.075 = S$5.9m ÷ (S$111m - S$32m) (Based on the trailing twelve months to December 2020).

Thus, Guan Chao Holdings has an ROCE of 7.5%. On its own, that's a low figure but it's around the 9.2% average generated by the Specialty Retail industry.

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're interested in investigating Guan Chao Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Guan Chao Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 44%, but since then they've fallen to 7.5%. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Guan Chao Holdings has done well to pay down its current liabilities to 29% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

We're a bit apprehensive about Guan Chao Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 19% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Guan Chao Holdings (of which 2 shouldn't be ignored!) that you should know about.

While Guan Chao 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. 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.
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