Here's What We Make Of WH Group's (HKG:288) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within WH Group (HKG:288), we weren't too hopeful.

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 WH Group, this is the formula:

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

0.13 = US$1.8b ÷ (US$17b - US$3.9b) (Based on the trailing twelve months to December 2019).

Thus, WH Group has an ROCE of 13%. That's a relatively normal return on capital, and it's around the 12% generated by the Food industry.

See our latest analysis for WH Group

Above you can see how the current ROCE for WH Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From WH Group's ROCE Trend?

In terms of WH Group's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 20%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect WH Group to turn into a multi-bagger.

The Bottom Line

In summary, it's unfortunate that WH Group is generating lower returns from the same amount of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 78% return over the last five years, so investors appear very optimistic. Regardless, we don't feel to comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to continue researching WH Group, you might be interested to know about the 2 warning signs that our analysis has discovered.

While WH Group 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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