Investors Could Be Concerned With Design Capital's (HKG:1545) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Design Capital (HKG:1545) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Design Capital is:

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

0.08 = S$5.5m ÷ (S$102m - S$34m) (Based on the trailing twelve months to June 2022).

Therefore, Design Capital has an ROCE of 8.0%. On its own that's a low return, but compared to the average of 4.3% generated by the Trade Distributors industry, it's much better.

View our latest analysis for Design Capital

Historical performance is a great place to start when researching a stock so above you can see the gauge for Design Capital's ROCE against it's prior returns. If you're interested in investigating Design Capital's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Design Capital, we didn't gain much confidence. Around five years ago the returns on capital were 31%, but since then they've fallen to 8.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Design Capital has done well to pay down its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Design Capital's ROCE

In summary, we're somewhat concerned by Design Capital's diminishing returns on increasing amounts of capital. Investors must expect better things on the horizon though because the stock has risen 18% in the last three years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you'd like to know more about Design Capital, we've spotted 5 warning signs, and 2 of them shouldn't be ignored.

While Design Capital 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. 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.