Zhongsheng Group Holdings (HKG:881) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Looking at Zhongsheng Group Holdings (HKG:881), it does have a high ROCE right now, but lets see how returns are trending.

Understanding 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. To calculate this metric for Zhongsheng Group Holdings, this is the formula:

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

0.20 = CN¥12b ÷ (CN¥87b - CN¥29b) (Based on the trailing twelve months to June 2022).

Therefore, Zhongsheng Group Holdings has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 11%.

See our latest analysis for Zhongsheng Group Holdings

Above you can see how the current ROCE for Zhongsheng Group 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.

How Are Returns Trending?

When we looked at the ROCE trend at Zhongsheng Group Holdings, we didn't gain much confidence. Historically returns on capital were even higher at 26%, but they have dropped over the last five years. However it looks like Zhongsheng Group 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Zhongsheng Group Holdings has decreased its current liabilities to 33% 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...

To conclude, we've found that Zhongsheng Group Holdings is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 113% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you're still interested in Zhongsheng Group Holdings it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.