Returns On Capital At Guan Chao Holdings (HKG:1872) Paint An Interesting Picture

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. In light of that, when we looked at Guan Chao Holdings (HKG:1872) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Guan Chao Holdings, this is the formula:

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

0.064 = S$4.8m ÷ (S$108m - S$33m) (Based on the trailing twelve months to June 2020).

So, Guan Chao Holdings has an ROCE of 6.4%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 11%.

See our latest analysis for Guan Chao Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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 past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Guan Chao Holdings, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 6.4% from 48% four years ago. 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, Guan Chao Holdings has done well to pay down its current liabilities to 31% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

From the above analysis, we find it rather worrisome that returns on capital and sales for Guan Chao Holdings have fallen, meanwhile the business is employing more capital than it was four years ago. Investors haven't taken kindly to these developments, since the stock has declined 42% from where it was year ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know more about Guan Chao Holdings, we've spotted 5 warning signs, and 2 of them don't sit too well with us.

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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