Returns Are Gaining Momentum At Wai Chi Holdings (HKG:1305)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Wai Chi Holdings (HKG:1305) and its trend of ROCE, we really liked what we saw.

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 Wai Chi Holdings, this is the formula:

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

0.099 = HK$85m ÷ (HK$2.7b - HK$1.8b) (Based on the trailing twelve months to June 2022).

So, Wai Chi Holdings has an ROCE of 9.9%. In absolute terms, that's a low return and it also under-performs the Semiconductor industry average of 14%.

View our latest analysis for Wai Chi Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Wai Chi Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Wai Chi Holdings, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. Over the last five years, returns on capital employed have risen substantially to 9.9%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 34%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 68% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Key Takeaway

All in all, it's terrific to see that Wai Chi Holdings is reaping the rewards from prior investments and is growing its capital base. Astute investors may have an opportunity here because the stock has declined 19% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing to note, we've identified 1 warning sign with Wai Chi Holdings and understanding it should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.