Returns On Capital Signal Tricky Times Ahead For Guan Chao Holdings (HKG:1872)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Analysts use this formula to calculate it for Guan Chao Holdings:

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

0.17 = S$14m ÷ (S$115m - S$31m) (Based on the trailing twelve months to December 2021).

So, Guan Chao Holdings has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 10% it's much better.

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 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 52%, but since then they've fallen to 17%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Guan Chao Holdings has decreased its current liabilities to 27% of total assets. Considering it used to be 81%, that's a huge drop in that ratio and it would explain the decline 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Guan Chao Holdings' ROCE

While returns have fallen for Guan Chao Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 95% over the last three years, so there could be other factors hurting the company's prospects. Therefore, we'd suggest researching the stock further to uncover more about the business.

If you want to continue researching Guan Chao Holdings, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.