The Returns On Capital At In Construction Holdings (HKG:1500) Don't Inspire Confidence

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. And from a first read, things don't look too good at In Construction Holdings (HKG:1500), so let's see why.

Understanding 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)

0.088 = HK$25m ÷ (HK$404m - HK$121m) (Based on the trailing twelve months to September 2020).

Thus, In Construction Holdings has an ROCE of 8.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.1%.

Check out our latest analysis for In Construction Holdings

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'd like to look at how In Construction Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

There is reason to be cautious about In Construction Holdings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 43% that they were earning five years ago. 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. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on In Construction Holdings becoming one if things continue as they have.

What We Can Learn From In Construction Holdings' ROCE

In summary, it's unfortunate that In Construction Holdings is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 59% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for In Construction Holdings (of which 1 is a bit unpleasant!) that you should know about.

While In Construction Holdings 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. 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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