Be Wary Of Edensoft Holdings (HKG:1147) And Its Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Edensoft Holdings (HKG:1147) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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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 Edensoft Holdings, this is the formula:

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

0.057 = CN¥12m ÷ (CN¥438m - CN¥236m) (Based on the trailing twelve months to December 2024).

Thus, Edensoft Holdings has an ROCE of 5.7%. On its own, that's a low figure but it's around the 6.7% average generated by the IT industry.

View our latest analysis for Edensoft Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Edensoft Holdings' past further, check out this free graph covering Edensoft Holdings' past earnings, revenue and cash flow.

So How Is Edensoft Holdings' ROCE Trending?

In terms of Edensoft Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 28% over the last five years. 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, Edensoft Holdings' current liabilities are still rather high at 54% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Edensoft Holdings. In light of this, the stock has only gained 23% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Edensoft Holdings does have some risks, we noticed 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

While Edensoft Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.