Smart-Core Holdings (HKG:2166) Is Reinvesting At Lower Rates Of Return

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Smart-Core Holdings (HKG:2166), it didn't seem to tick all of these boxes.

What is 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 Smart-Core Holdings:

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 8.1% generated by the Electronic industry.

View 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.

So How Is Smart-Core Holdings' ROCE Trending?

In terms of Smart-Core Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 15% from 46% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

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. 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. Keep in mind 67% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Smart-Core Holdings. These growth trends haven't led to growth returns though, since the stock has fallen 17% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One final note, you should learn about the 4 warning signs we've spotted with Smart-Core Holdings (including 1 which can't be ignored) .

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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