Fulu Holdings (HKG:2101) May Have Issues Allocating Its Capital

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think Fulu Holdings (HKG:2101) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Fulu Holdings, this is the formula:

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

0.12 = CN¥128m ÷ (CN¥1.3b - CN¥244m) (Based on the trailing twelve months to June 2021).

Therefore, Fulu Holdings has an ROCE of 12%. By itself that's a normal return on capital and it's in line with the industry's average returns of 12%.

Check out our latest analysis for Fulu Holdings

Above you can see how the current ROCE for Fulu Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Fulu Holdings' ROCE Trending?

On the surface, the trend of ROCE at Fulu Holdings doesn't inspire confidence. Over the last three years, returns on capital have decreased to 12% from 55% three years ago. 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 side note, Fulu Holdings has done well to pay down 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.

What We Can Learn From Fulu Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Fulu Holdings is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 25% to shareholders over the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Fulu Holdings (of which 1 is concerning!) that you should know about.

While Fulu Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.

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