Hengxin Technology's (HKG:1085) Returns On Capital Not Reflecting Well On The Business

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating Hengxin Technology (HKG:1085), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Hengxin Technology, this is the formula:

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

0.057 = CN¥110m ÷ (CN¥2.7b - CN¥799m) (Based on the trailing twelve months to June 2023).

So, Hengxin Technology has an ROCE of 5.7%. Even though it's in line with the industry average of 5.7%, it's still a low return by itself.

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

So How Is Hengxin Technology's ROCE Trending?

On the surface, the trend of ROCE at Hengxin Technology doesn't inspire confidence. To be more specific, ROCE has fallen from 9.3% over the last five years. However it looks like Hengxin Technology 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Hengxin Technology's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 13% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

Hengxin Technology does have some risks, we noticed 3 warning signs (and 2 which are concerning) we think you should know about.

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.

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.