Capital Allocation Trends At Edensoft Holdings (HKG:1147) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. In light of that, when we looked at Edensoft Holdings (HKG:1147) and its ROCE trend, we weren't exactly thrilled.

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 Edensoft Holdings, this is the formula:

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

0.052 = CN¥11m ÷ (CN¥430m - CN¥221m) (Based on the trailing twelve months to June 2021).

So, Edensoft Holdings has an ROCE of 5.2%. In absolute terms, that's a low return but it's around the IT industry average of 6.3%.

View our latest analysis for Edensoft Holdings

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

What Can We Tell From Edensoft Holdings' ROCE Trend?

When we looked at the ROCE trend at Edensoft Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 51% over the last four 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Edensoft Holdings has done well to pay down its current liabilities to 51% 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. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From Edensoft Holdings' ROCE

While returns have fallen for Edensoft Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 35% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know more about Edensoft Holdings, we've spotted 3 warning signs, and 1 of them is concerning.

While Edensoft 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.

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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.