Here's What's Concerning About Xuan Wu Cloud Technology Holdings' (HKG:2392) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Xuan Wu Cloud Technology Holdings (HKG:2392) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Xuan Wu Cloud Technology Holdings:

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

0.0067 = CN¥2.2m ÷ (CN¥634m - CN¥298m) (Based on the trailing twelve months to December 2024).

Therefore, Xuan Wu Cloud Technology Holdings has an ROCE of 0.7%. In absolute terms, that's a low return and it also under-performs the Software industry average of 5.5%.

See our latest analysis for Xuan Wu Cloud Technology 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'd like to look at how Xuan Wu Cloud Technology Holdings has performed in the past in other metrics, you can view this free graph of Xuan Wu Cloud Technology Holdings' past earnings, revenue and cash flow.

What Can We Tell From Xuan Wu Cloud Technology Holdings' ROCE Trend?

In terms of Xuan Wu Cloud Technology Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 0.7% from 6.1% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a separate but related note, it's important to know that Xuan Wu Cloud Technology Holdings has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

We're a bit apprehensive about Xuan Wu Cloud Technology Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Unsurprisingly then, the stock has dived 75% over the last three years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Xuan Wu Cloud Technology Holdings (of which 1 is significant!) that you should know about.

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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.