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

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. 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 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. Analysts use this formula to calculate it for Hengxin Technology:

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

0.05 = CN¥92m ÷ (CN¥2.6b - CN¥753m) (Based on the trailing twelve months to June 2022).

Therefore, Hengxin Technology has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 6.8%.

Check out our latest analysis for Hengxin Technology

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

How Are Returns Trending?

In terms of Hengxin Technology's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.0% from 9.5% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 29%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Hengxin Technology is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 134% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 1 warning sign with Hengxin Technology and understanding this should be part of your investment process.

While Hengxin Technology 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.