What Boer Power Holdings' (HKG:1685) Returns On Capital Can Tell Us

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount 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. In light of that, from a first glance at Boer Power Holdings (HKG:1685), we've spotted some signs that it could be struggling, so let's investigate.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Boer Power Holdings is:

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

0.11 = CN¥70m ÷ (CN¥1.9b - CN¥1.2b) (Based on the trailing twelve months to June 2020).

Therefore, Boer Power Holdings has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 8.9% generated by the Electrical industry.

View our latest analysis for Boer Power 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 Boer Power Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Boer Power Holdings' ROCE Trending?

The trend of returns that Boer Power Holdings is generating are raising some concerns. Unfortunately, returns have declined substantially over the last five years to the 11% we see today. What's equally concerning is that the amount of capital deployed in the business has shrunk by 72% over that same period. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a side note, Boer Power Holdings' current liabilities have increased over the last five years to 66% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

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 96% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Boer Power Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

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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