Stock Analysis

Here's What's Concerning About Cosmos Machinery Enterprises' (HKG:118) Returns On Capital

SEHK:118
Source: Shutterstock

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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 indicates the company is producing less profit from its investments and its total assets are decreasing. In light of that, from a first glance at Cosmos Machinery Enterprises (HKG:118), we've spotted some signs that it could be struggling, so let's investigate.

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. The formula for this calculation on Cosmos Machinery Enterprises is:

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

0.015 = HK$24m ÷ (HK$2.6b - HK$1.0b) (Based on the trailing twelve months to December 2022).

Thus, Cosmos Machinery Enterprises has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 7.0%.

Check out our latest analysis for Cosmos Machinery Enterprises

roce
SEHK:118 Return on Capital Employed June 13th 2023

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.

So How Is Cosmos Machinery Enterprises' ROCE 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 3.4%, 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. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. 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 related note, Cosmos Machinery Enterprises has decreased its current liabilities to 39% 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 Conclusion...

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. Investors haven't taken kindly to these developments, since the stock has declined 55% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing, we've spotted 2 warning signs facing Cosmos Machinery Enterprises that you might find interesting.

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.

New: AI Stock Screener & Alerts

Our new AI Stock Screener scans the market every day to uncover opportunities.

• Dividend Powerhouses (3%+ Yield)
• Undervalued Small Caps with Insider Buying
• High growth Tech and AI Companies

Or build your own from over 50 metrics.

Explore Now for Free

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.