When researching a stock for investment, what can tell us that the company is in decline? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that’s often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. On that note, looking into Allan International Holdings (HKG:684), we weren’t too upbeat about how things were going.
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 Allan International Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.017 = HK$21m ÷ (HK$1.5b – HK$246m) (Based on the trailing twelve months to March 2020).
Therefore, Allan International Holdings has an ROCE of 1.7%. Ultimately, that’s a low return and it under-performs the Consumer Durables industry average of 9.9%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Allan International Holdings’ ROCE against it’s prior returns. If you’re interested in investigating Allan International Holdings’ past further, check out this free graph of past earnings, revenue and cash flow.
What The Trend Of ROCE Can Tell Us
In terms of Allan International Holdings’ historical ROCE movements, the trend doesn’t inspire confidence. Unfortunately the returns on capital have diminished from the 3.7% that they were earning five years ago. On top of that, it’s worth noting that the amount of capital employed within the business has remained relatively steady. 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 Allan International Holdings to turn into a multi-bagger.On a related note, Allan International Holdings has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. What’s more, this can reduce some aspects of risk to the business because now the company’s suppliers or short-term creditors are funding less of its operations. 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.
In the end, the trend of lower returns on the same amount of capital isn’t typically an indication that we’re looking at a growth stock. Long term shareholders who’ve owned the stock over the last five years have experienced a 16% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren’t great in these areas, we’d consider looking elsewhere.
One more thing: We’ve identified 3 warning signs with Allan International Holdings (at least 1 which can’t be ignored) , and understanding these 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.
If you decide to trade Allan International Holdings, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.