Capital Allocation Trends At Royal Deluxe Holdings (HKG:3789) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Royal Deluxe Holdings (HKG:3789) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Royal Deluxe Holdings, this is the formula:

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

0.023 = HK$7.2m ÷ (HK$480m - HK$162m) (Based on the trailing twelve months to March 2024).

Therefore, Royal Deluxe Holdings has an ROCE of 2.3%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.3%.

View our latest analysis for Royal Deluxe Holdings

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Royal Deluxe Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.3% from 23% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Royal Deluxe Holdings' ROCE

While returns have fallen for Royal Deluxe Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 73% over the last five years, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

On a final note, we found 4 warning signs for Royal Deluxe Holdings (3 are concerning) you should be aware of.

While Royal Deluxe 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.

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