Investors Could Be Concerned With MEGAIN Holding (Cayman)'s (HKG:6939) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. 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 MEGAIN Holding (Cayman) (HKG:6939) 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)?

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 MEGAIN Holding (Cayman), this is the formula:

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

0.11 = CN¥38m ÷ (CN¥360m - CN¥30m) (Based on the trailing twelve months to December 2021).

So, MEGAIN Holding (Cayman) has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the Semiconductor industry.

Check out our latest analysis for MEGAIN Holding (Cayman)

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

How Are Returns Trending?

On the surface, the trend of ROCE at MEGAIN Holding (Cayman) doesn't inspire confidence. Over the last four years, returns on capital have decreased to 11% from 55% four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, MEGAIN Holding (Cayman) has decreased its current liabilities to 8.4% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On MEGAIN Holding (Cayman)'s ROCE

In summary, MEGAIN Holding (Cayman) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 25% in the last year. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

MEGAIN Holding (Cayman) does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those don't sit too well with us...

While MEGAIN Holding (Cayman) isn't earning the highest return, check out this free list of companies that are 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.