VSTECS Holdings (HKG:856) Could Be Struggling To Allocate Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating VSTECS Holdings (HKG:856), we don't think it's current trends fit the mold of a multi-bagger.

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 VSTECS Holdings, this is the formula:

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

0.16 = HK$1.4b ÷ (HK$31b - HK$22b) (Based on the trailing twelve months to June 2023).

So, VSTECS Holdings has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 6.1% generated by the Electronic industry.

See our latest analysis for VSTECS Holdings

In the above chart we have measured VSTECS Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For VSTECS Holdings Tell Us?

In terms of VSTECS Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 16% from 24% 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.

Another thing to note, VSTECS Holdings has a high ratio of current liabilities to total assets of 71%. 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.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for VSTECS Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. 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.

One more thing to note, we've identified 2 warning signs with VSTECS Holdings and understanding these should be part of your investment process.

While VSTECS Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.