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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. In light of that, when we looked at MEGAIN Holding (Cayman) (HKG:6939) and its ROCE trend, we weren't exactly thrilled.
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 MEGAIN Holding (Cayman) is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0075 = CN¥2.7m ÷ (CN¥395m - CN¥34m) (Based on the trailing twelve months to June 2024).
Thus, MEGAIN Holding (Cayman) has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 6.1%.
View our latest analysis for MEGAIN Holding (Cayman)
Historical performance is a great place to start when researching a stock so above you can see the gauge for MEGAIN Holding (Cayman)'s ROCE against it's prior returns. If you're interested in investigating MEGAIN Holding (Cayman)'s past further, check out this free graph covering MEGAIN Holding (Cayman)'s past earnings, revenue and cash flow.
So How Is MEGAIN Holding (Cayman)'s ROCE Trending?
In terms of MEGAIN Holding (Cayman)'s historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 39% over the last five years. 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, MEGAIN Holding (Cayman) has done well to pay down its current liabilities to 8.5% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.
What We Can Learn From MEGAIN Holding (Cayman)'s ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for MEGAIN Holding (Cayman) have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 65% from where it was three years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
If you want to know some of the risks facing MEGAIN Holding (Cayman) we've found 5 warning signs (3 don't sit too well with us!) that you should be aware of before investing here.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.