Investors Could Be Concerned With Smart-Core Holdings' (HKG:2166) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Smart-Core Holdings (HKG:2166) 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?

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 Smart-Core Holdings, this is the formula:

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

0.15 = HK$105m ÷ (HK$2.2b - HK$1.5b) (Based on the trailing twelve months to December 2020).

So, Smart-Core Holdings has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Electronic industry.

See our latest analysis for Smart-Core Holdings

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'd like to look at how Smart-Core Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Smart-Core Holdings Tell Us?

On the surface, the trend of ROCE at Smart-Core Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 46% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Smart-Core Holdings has done well to pay down its current liabilities to 67% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Smart-Core Holdings' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Smart-Core Holdings is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 31% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

One more thing: We've identified 5 warning signs with Smart-Core Holdings (at least 3 which are potentially serious) , and understanding these would certainly be useful.

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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