Capital Allocation Trends At Huabang Financial Holdings (HKG:3638) Aren't Ideal

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. In light of that, when we looked at Huabang Financial Holdings (HKG:3638) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Huabang Financial Holdings is:

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

0.053 = HK$33m ÷ (HK$995m - HK$365m) (Based on the trailing twelve months to September 2020).

So, Huabang Financial Holdings has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the Electronic industry average of 8.1%.

Check out our latest analysis for Huabang Financial Holdings

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

So How Is Huabang Financial Holdings' ROCE Trending?

When we looked at the ROCE trend at Huabang Financial Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Huabang Financial Holdings has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Huabang Financial Holdings is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 42% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to know some of the risks facing Huabang Financial Holdings we've found 3 warning signs (2 can't be ignored!) that you should be aware of before investing here.

While Huabang Financial 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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