Investors Could Be Concerned With Digital China Holdings' (HKG:861) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Digital China Holdings (HKG:861), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Digital China Holdings is:

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

0.023 = HK$388m ÷ (HK$28b - HK$11b) (Based on the trailing twelve months to December 2020).

Therefore, Digital China Holdings has an ROCE of 2.3%. Ultimately, that's a low return and it under-performs the IT industry average of 8.1%.

See our latest analysis for Digital China Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Digital China Holdings' ROCE against it's prior returns. If you'd like to look at how Digital China Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Digital China Holdings Tell Us?

In terms of Digital China Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 3.9% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Digital China Holdings has done well to pay down its current liabilities to 39% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Digital China Holdings' ROCE

While returns have fallen for Digital China Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 24% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing, we've spotted 2 warning signs facing Digital China Holdings that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
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