Cosmos Machinery Enterprises (HKG:118) Will Be Hoping To Turn Its Returns On Capital Around

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. 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 that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Cosmos Machinery Enterprises, this is the formula:

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).

Therefore, 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 7.1%.

Check out 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 want to delve into the historical earnings, revenue and cash flow of Cosmos Machinery Enterprises, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

We are a bit worried about the trend of returns on capital at Cosmos Machinery Enterprises. To be more specific, the ROCE was 4.3% five years ago, but since then it has dropped noticeably. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Cosmos Machinery Enterprises becoming one if things continue as they have.

On a side note, Cosmos Machinery Enterprises' current liabilities are still rather high at 40% of total assets. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

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 29% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 2 warning signs for Cosmos Machinery Enterprises you'll probably want to know about.

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.

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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.