Returns On Capital At Novacon Technology Group (HKG:8635) Paint A Concerning Picture

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Novacon Technology Group (HKG:8635) 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. The formula for this calculation on Novacon Technology Group is:

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

0.038 = HK$5.0m ÷ (HK$137m - HK$7.2m) (Based on the trailing twelve months to March 2023).

Thus, Novacon Technology Group has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Software industry average of 5.3%.

See our latest analysis for Novacon Technology Group

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 want to delve into the historical earnings, revenue and cash flow of Novacon Technology Group, check out these free graphs here.

The Trend Of ROCE

In terms of Novacon Technology Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 39%, but since then they've fallen to 3.8%. However it looks like Novacon Technology Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Novacon Technology Group has done well to pay down its current liabilities to 5.2% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Novacon Technology Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 83% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Novacon Technology Group does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are a bit unpleasant...

While Novacon Technology Group 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.