Shun Wo Group Holdings (HKG:1591) May Have Issues Allocating Its Capital

If we're looking to avoid a business that is in decline, what are the trends that can warn us ahead of time? 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. On that note, looking into Shun Wo Group Holdings (HKG:1591), we weren't too upbeat about how things were going.

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

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. Analysts use this formula to calculate it for Shun Wo Group Holdings:

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

0.13 = HK$12m ÷ (HK$117m - HK$24m) (Based on the trailing twelve months to September 2021).

Therefore, Shun Wo Group Holdings has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Construction industry.

See our latest analysis for Shun Wo Group 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're interested in investigating Shun Wo Group Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of returns that Shun Wo Group Holdings is generating are raising some concerns. To be more specific, today's ROCE was 27% five years ago but has since fallen to 13%. In addition to that, Shun Wo Group Holdings is now employing 38% less capital than it was five years ago. 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.

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. Unsurprisingly then, the stock has dived 79% over the last five years, so investors are recognizing these changes and don't like the company's prospects. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know more about Shun Wo Group Holdings, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.

While Shun Wo Group 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. 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.