Be Wary Of KPa-BM Holdings (HKG:2663) And Its Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at KPa-BM Holdings (HKG:2663), it does have a high ROCE right now, but lets see how returns are trending.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on KPa-BM Holdings is:

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

0.23 = HK$59m ÷ (HK$448m - HK$198m) (Based on the trailing twelve months to September 2020).

So, KPa-BM Holdings has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Construction industry average of 9.1%.

Check out our latest analysis for KPa-BM 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 KPa-BM 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 KPa-BM Holdings' ROCE Trend?

When we looked at the ROCE trend at KPa-BM Holdings, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 52%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, KPa-BM Holdings has decreased its current liabilities to 44% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 44% is still pretty high, so those risks are still somewhat prevalent.

In Conclusion...

We're a bit apprehensive about KPa-BM Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 23% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Like most companies, KPa-BM Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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.
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