Clifford Modern Living Holdings (HKG:3686) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Clifford Modern Living Holdings (HKG:3686) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Clifford Modern Living Holdings, this is the formula:

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

0.19 = CN¥128m ÷ (CN¥812m - CN¥154m) (Based on the trailing twelve months to June 2022).

Therefore, Clifford Modern Living Holdings has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Industrials industry average of 3.1% it's much better.

Our analysis indicates that 3686 is potentially undervalued!

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

What Can We Tell From Clifford Modern Living Holdings' ROCE Trend?

In terms of Clifford Modern Living Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 19% from 28% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Clifford Modern Living Holdings has done well to pay down its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Clifford Modern Living Holdings' ROCE

In summary, Clifford Modern Living Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Additionally, the stock's total return to shareholders over the last five years has been flat, which isn't too surprising. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

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

While Clifford Modern Living 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.