Hengxin Technology (HKG:1085) Is Reinvesting At Lower Rates Of Return

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Hengxin Technology (HKG:1085) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. The formula for this calculation on Hengxin Technology is:

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

0.019 = CN¥33m ÷ (CN¥2.2b - CN¥493m) (Based on the trailing twelve months to June 2021).

So, Hengxin Technology has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Communications industry average of 7.1%.

Check out our latest analysis for Hengxin Technology

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're interested in investigating Hengxin Technology's past further, check out this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Hengxin Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.9% from 9.5% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Hengxin Technology's current liabilities have increased over the last five years to 22% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

We're a bit apprehensive about Hengxin Technology because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 163%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing Hengxin Technology we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

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.