Returns On Capital Signal Difficult Times Ahead For Analogue Holdings (HKG:1977)

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. 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 Analogue Holdings (HKG:1977), so let's see why.

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 Analogue Holdings:

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

0.12 = HK$256m ÷ (HK$3.9b - HK$1.8b) (Based on the trailing twelve months to June 2021).

So, Analogue Holdings has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Construction industry average of 8.8% it's much better.

See our latest analysis for Analogue Holdings

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

So How Is Analogue Holdings' ROCE Trending?

There is reason to be cautious about Analogue Holdings, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 17% that they were earning four years ago. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last four years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Analogue Holdings becoming one if things continue as they have.

On a side note, Analogue Holdings' current liabilities are still rather high at 46% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Analogue Holdings' ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these concerning fundamentals, the stock has performed strongly with a 17% return over the last year, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

If you want to continue researching Analogue Holdings, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Analogue 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.