Capital Allocation Trends At Shun Wo Group Holdings (HKG:1591) Aren't Ideal

What financial metrics can indicate to us that a company is maturing or even in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. 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 Shun Wo Group Holdings (HKG:1591), we've spotted some signs that it could be struggling, so let's investigate.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Shun Wo Group Holdings, this is the formula:

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

0.075 = HK$7.8m ÷ (HK$150m - HK$46m) (Based on the trailing twelve months to September 2022).

So, Shun Wo Group Holdings has an ROCE of 7.5%. Even though it's in line with the industry average of 7.1%, it's still a low return by itself.

View our latest analysis for Shun Wo Group Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shun Wo Group Holdings' ROCE against it's prior returns. If you'd like to look at how Shun Wo Group Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Shun Wo Group Holdings' ROCE Trend?

In terms of Shun Wo Group Holdings' historical ROCE trend, it isn't fantastic. To be more specific, today's ROCE was 9.7% five years ago but has since fallen to 7.5%. On top of that, the business is utilizing 35% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. If these underlying trends continue, we wouldn't be too optimistic going forward.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 31%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 7.5%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

What We Can Learn From Shun Wo Group Holdings' ROCE

In short, lower returns and decreasing amounts capital employed in the business doesn't fill us with confidence. This could explain why the stock has sunk a total of 79% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Shun Wo Group Holdings (including 1 which can't be ignored) .

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.