There Are Reasons To Feel Uneasy About Novacon Technology Group's (HKG:8635) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Novacon Technology Group (HKG:8635), it didn't seem to tick all of these boxes.

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. The formula for this calculation on Novacon Technology Group is:

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

0.11 = HK$14m ÷ (HK$137m - HK$5.9m) (Based on the trailing twelve months to September 2022).

Therefore, Novacon Technology Group has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 4.2% generated by the Software industry.

View our latest analysis for Novacon Technology Group

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

What The Trend Of ROCE Can Tell Us

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 11%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Novacon Technology Group has done well to pay down its current liabilities to 4.3% 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. 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.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Novacon Technology Group. These trends are starting to be recognized by investors since the stock has delivered a 8.6% gain to shareholders who've held over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you want to know some of the risks facing Novacon Technology Group we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.