What Do The Returns On Capital At Digital China Holdings (HKG:861) Tell Us?

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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Digital China Holdings (HKG:861) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is Return On Capital Employed (ROCE)?

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. To calculate this metric for Digital China Holdings, this is the formula:

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

0.032 = HK$489m ÷ (HK$25b - HK$9.6b) (Based on the trailing twelve months to June 2020).

Therefore, Digital China Holdings has an ROCE of 3.2%. Ultimately, that's a low return and it under-performs the IT industry average of 8.6%.

See our latest analysis for Digital China Holdings

Above you can see how the current ROCE for Digital China Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Digital China Holdings here for free.

What The Trend Of ROCE Can Tell Us

There are better returns on capital out there than what we're seeing at Digital China Holdings. The company has employed 23% more capital in the last five years, and the returns on that capital have remained stable at 3.2%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a side note, Digital China Holdings has done well to reduce current liabilities to 39% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Key Takeaway

As we've seen above, Digital China Holdings' returns on capital haven't increased but it is reinvesting in the business. And with the stock having returned a mere 15% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you want to continue researching Digital China Holdings, you might be interested to know about the 1 warning sign that our analysis has discovered.

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. 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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