Returns At Cosmos Machinery Enterprises (HKG:118) Are On The Way Up

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Cosmos Machinery Enterprises' (HKG:118) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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)

0.034 = HK$54m ÷ (HK$2.8b - HK$1.2b) (Based on the trailing twelve months to December 2020).

Thus, Cosmos Machinery Enterprises has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.1%.

Check out our latest analysis for Cosmos Machinery Enterprises

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. 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

Shareholders will be relieved that Cosmos Machinery Enterprises has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 3.4%, which is always encouraging. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. So if you're looking for high growth, you'll want to see a business's capital employed also increasing.

On a separate but related note, it's important to know that Cosmos Machinery Enterprises has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

As discussed above, Cosmos Machinery Enterprises appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has only returned 18% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

On a final note, we've found 1 warning sign 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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