Returns On Capital Signal Tricky Times Ahead For HK Asia Holdings (HKG:1723)

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at HK Asia Holdings (HKG:1723) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

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. To calculate this metric for HK Asia Holdings, this is the formula:

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

0.069 = HK$10m ÷ (HK$183m - HK$34m) (Based on the trailing twelve months to March 2021).

So, HK Asia Holdings has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Electronic industry average of 7.5%.

View our latest analysis for HK Asia Holdings

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

The Trend Of ROCE

When we looked at the ROCE trend at HK Asia Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 57% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, HK Asia Holdings has done well to pay down its current liabilities to 18% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for HK Asia Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 122%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

On a final note, we found 4 warning signs for HK Asia Holdings (2 can't be ignored) you should be aware of.

While HK Asia Holdings 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.

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.

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