Pangaea Connectivity Technology (HKG:1473) May Have Issues Allocating Its Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 investigating Pangaea Connectivity Technology (HKG:1473), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Pangaea Connectivity Technology:

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

0.093 = HK$26m ÷ (HK$890m - HK$606m) (Based on the trailing twelve months to September 2022).

Thus, Pangaea Connectivity Technology has an ROCE of 9.3%. In absolute terms, that's a low return but it's around the Electronic industry average of 9.6%.

See our latest analysis for Pangaea Connectivity Technology

Historical performance is a great place to start when researching a stock so above you can see the gauge for Pangaea Connectivity Technology's ROCE against it's prior returns. If you're interested in investigating Pangaea Connectivity Technology's past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Pangaea Connectivity Technology's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 46%, but since then they've fallen to 9.3%. However it looks like Pangaea Connectivity 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.

On a separate but related note, it's important to know that Pangaea Connectivity Technology has a current liabilities to total assets ratio of 68%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Pangaea Connectivity Technology's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 11% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing: We've identified 6 warning signs with Pangaea Connectivity Technology (at least 2 which make us uncomfortable) , and understanding these would certainly be useful.

While Pangaea Connectivity Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.