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

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. 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.

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 Royal Deluxe Holdings, this is the formula:

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

0.005 = HK$1.5m ÷ (HK$405m - HK$98m) (Based on the trailing twelve months to March 2023).

So, Royal Deluxe Holdings has an ROCE of 0.5%. Ultimately, that's a low return and it under-performs the Construction industry average of 6.0%.

See 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 want to delve into the historical earnings, revenue and cash flow of Royal Deluxe Holdings, check out these free graphs here.

SWOT Analysis for Royal Deluxe Holdings

What Does the ROCE Trend For Royal Deluxe Holdings Tell Us?

When we looked at the ROCE trend at Royal Deluxe Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 29% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Royal Deluxe Holdings has done well to pay down its current liabilities to 24% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

What We Can Learn From 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 71% 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.

Royal Deluxe Holdings does come with some risks though, we found 4 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.