Should You Be Impressed By Smart-Core Holdings' (HKG:2166) Returns on Capital?

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. 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 briefly looking over the numbers, we don't think Smart-Core Holdings (HKG:2166) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Smart-Core Holdings, this is the formula:

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

0.13 = HK$84m ÷ (HK$1.5b - HK$834m) (Based on the trailing twelve months to June 2020).

Thus, Smart-Core Holdings has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 7.7% generated by the Electronic industry.

View our latest analysis for Smart-Core Holdings

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

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

In terms of Smart-Core Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 46% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Smart-Core Holdings has decreased its current liabilities to 55% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line On Smart-Core Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Smart-Core Holdings' reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 21% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Smart-Core Holdings (of which 1 can't be ignored!) that you should know about.

While Smart-Core 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.

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This article by Simply Wall St is general in nature. 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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