Investors Could Be Concerned With Royal Deluxe Holdings' (HKG:3789) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at Royal Deluxe Holdings (HKG:3789) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Royal Deluxe Holdings is:

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

0.014 = HK$3.9m ÷ (HK$416m - HK$130m) (Based on the trailing twelve months to March 2022).

Therefore, Royal Deluxe Holdings has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 7.3%.

Check out our latest analysis for Royal Deluxe 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're interested in investigating Royal Deluxe Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Royal Deluxe Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 51% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Royal Deluxe Holdings has decreased its current liabilities to 31% 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 Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Royal Deluxe Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 55% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Royal Deluxe Holdings (including 1 which shouldn't be ignored) .

While Royal Deluxe Holdings 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.