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. Basically the company is earning less on its investments and it is also reducing its total assets. In light of that, from a first glance at In Construction Holdings (HKG:1500), we've spotted some signs that it could be struggling, so let's investigate.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for In Construction Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = HK$31m ÷ (HK$363m - HK$75m) (Based on the trailing twelve months to March 2021).
So, In Construction Holdings has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.2% generated by the Construction industry.
Historical performance is a great place to start when researching a stock so above you can see the gauge for In Construction Holdings' ROCE against it's prior returns. If you're interested in investigating In Construction Holdings' past further, check out this free graph of past earnings, revenue and cash flow.
How Are Returns Trending?
We are a bit worried about the trend of returns on capital at In Construction Holdings. About five years ago, returns on capital were 33%, 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. 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 In Construction Holdings to turn into a multi-bagger.
The Bottom Line
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. It should come as no surprise then that the stock has fallen 57% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
If you'd like to know more about In Construction Holdings, we've spotted 3 warning signs, and 1 of them is a bit concerning.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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.
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