Binhai Investment (HKG:2886) Will Will Want To Turn Around Its Return Trends

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Binhai Investment (HKG:2886), 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. The formula for this calculation on Binhai Investment is:

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

0.11 = HK$346m ÷ (HK$7.1b - HK$3.8b) (Based on the trailing twelve months to December 2020).

Therefore, Binhai Investment has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Gas Utilities industry.

See our latest analysis for Binhai Investment

In the above chart we have measured Binhai Investment's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Binhai Investment here for free.

What Does the ROCE Trend For Binhai Investment Tell Us?

On the surface, the trend of ROCE at Binhai Investment doesn't inspire confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 11%. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 54%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 11%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

To conclude, we've found that Binhai Investment is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 27% in the last five years. 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.

One more thing: We've identified 4 warning signs with Binhai Investment (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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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