Watts International Maritime (HKG:2258) Might Be Having Difficulty Using Its Capital Effectively

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Watts International Maritime (HKG:2258) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Watts International Maritime, this is the formula:

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

0.071 = CN¥68m ÷ (CN¥3.2b - CN¥2.3b) (Based on the trailing twelve months to June 2022).

So, Watts International Maritime has an ROCE of 7.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 7.0%.

Our analysis indicates that 2258 is potentially undervalued!

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

What Does the ROCE Trend For Watts International Maritime Tell Us?

On the surface, the trend of ROCE at Watts International Maritime doesn't inspire confidence. To be more specific, ROCE has fallen from 17% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Watts International Maritime's current liabilities are still rather high at 70% 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Watts International Maritime's ROCE

To conclude, we've found that Watts International Maritime is reinvesting in the business, but returns have been falling. Moreover, since the stock has crumbled 79% over the last three years, it appears investors are expecting the worst. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

Watts International Maritime does come with some risks though, we found 5 warning signs in our investment analysis, and 2 of those are a bit concerning...

While Watts International Maritime isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.