Smart-Core Holdings (HKG:2166) Might Be Having Difficulty Using Its Capital Effectively

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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. 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)

0.13 = HK$122m ÷ (HK$1.9b - HK$1.0b) (Based on the trailing twelve months to June 2024).

So, Smart-Core Holdings has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 7.2% it's much better.

Check out 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 covering Smart-Core Holdings' past earnings, revenue and cash flow.

What Can We Tell From Smart-Core Holdings' ROCE Trend?

When we looked at the ROCE trend at Smart-Core Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 17% five years ago. 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, Smart-Core Holdings' current liabilities are still rather high at 52% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Smart-Core Holdings' ROCE

We're a bit apprehensive about Smart-Core Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 29% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

Smart-Core Holdings does have some risks though, and we've spotted 2 warning signs for Smart-Core Holdings that you might be interested in.

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. 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.