Here’s What’s Concerning About Sunlight Technology Holdings’ (HKG:1950) Returns On Capital
If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Sunlight Technology Holdings (HKG:1950), we don't think it's current trends fit the mold of a multi-bagger.
Understanding 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. To calculate this metric for Sunlight Technology Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.024 = CN¥5.7m ÷ (CN¥264m - CN¥26m) (Based on the trailing twelve months to December 2020).
Thus, Sunlight Technology Holdings has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.5%.
View our latest analysis for Sunlight Technology Holdings
Historical performance is a great place to start when researching a stock so above you can see the gauge for Sunlight Technology Holdings' ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Sunlight Technology Holdings, check out these free graphs here.
What The Trend Of ROCE Can Tell Us
We weren't thrilled with the trend because Sunlight Technology Holdings' ROCE has reduced by 89% over the last four years, while the business employed 113% more capital. Usually this isn't ideal, but given Sunlight Technology Holdings conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Sunlight Technology Holdings' earnings and if they change as a result from the capital raise.
On a related note, Sunlight Technology Holdings has decreased its current liabilities to 9.8% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Sunlight Technology Holdings' ROCE
In summary, we're somewhat concerned by Sunlight Technology Holdings' diminishing returns on increasing amounts of capital. This could explain why the stock has sunk a total of 76% in the last year. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.
One final note, you should learn about the 4 warning signs we've spotted with Sunlight Technology Holdings (including 1 which is a bit unpleasant) .
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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