Cosmos Machinery Enterprises (HKG:118) May Have Issues Allocating Its Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. Having said that, after a brief look, Cosmos Machinery Enterprises (HKG:118) we aren't filled with optimism, but let's investigate further.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Cosmos Machinery Enterprises:

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

0.014 = HK$22m ÷ (HK$2.6b - HK$1.1b) (Based on the trailing twelve months to June 2023).

So, Cosmos Machinery Enterprises has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 7.4%.

View our latest analysis for Cosmos Machinery Enterprises

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cosmos Machinery Enterprises' ROCE against it's prior returns. If you're interested in investigating Cosmos Machinery Enterprises' past further, check out this free graph covering Cosmos Machinery Enterprises' past earnings, revenue and cash flow.

How Are Returns Trending?

We are a bit worried about the trend of returns on capital at Cosmos Machinery Enterprises. About five years ago, returns on capital were 4.3%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Cosmos Machinery Enterprises to turn into a multi-bagger.

Another thing to note, Cosmos Machinery Enterprises has a high ratio of current liabilities to total assets of 40%. 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.

In Conclusion...

In summary, it's unfortunate that Cosmos Machinery Enterprises is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 54% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we've found 2 warning signs for Cosmos Machinery Enterprises that we think you should be aware of.

While Cosmos Machinery Enterprises 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.