Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Hong Kong Shanghai Alliance Holdings (HKG:1001) and its trend of ROCE, we really liked what we saw.
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. The formula for this calculation on Hong Kong Shanghai Alliance Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = HK$212m ÷ (HK$2.8b - HK$1.2b) (Based on the trailing twelve months to September 2023).
Therefore, Hong Kong Shanghai Alliance Holdings has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 6.2% it's much better.
Check out our latest analysis for Hong Kong Shanghai Alliance Holdings
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hong Kong Shanghai Alliance Holdings' ROCE against it's prior returns. If you're interested in investigating Hong Kong Shanghai Alliance Holdings' past further, check out this free graph covering Hong Kong Shanghai Alliance Holdings' past earnings, revenue and cash flow.
How Are Returns Trending?
Hong Kong Shanghai Alliance Holdings has broken into the black (profitability) and we're sure it's a sight for sore eyes. While the business was unprofitable in the past, it's now turned things around and is earning 14% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.
On a separate but related note, it's important to know that Hong Kong Shanghai Alliance Holdings has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. 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.
What We Can Learn From Hong Kong Shanghai Alliance Holdings' ROCE
To bring it all together, Hong Kong Shanghai Alliance Holdings has done well to increase the returns it's generating from its capital employed. And since the stock has fallen 36% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.
One more thing: We've identified 3 warning signs with Hong Kong Shanghai Alliance Holdings (at least 1 which shouldn't be ignored) , and understanding these would certainly be useful.
While Hong Kong Shanghai Alliance 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com